International Review of Equity Market Structure Regulation · Review of Equity Market Structure Regulation 1 The research staff of the Program on International Financial Systems (“PIFS”)

~1 ~

Program on International Financial Systems

International Review of Equity

Market Structure Regulation

October 2019

© Program on International Financial Systems 2019. All rights reserved. Limited extracts may be repro-duced or translated provided the source is stated.

The Program on International Financial Systems (PIFS) is a 501(c)(3) organization that conducts research on issues impacting the global financial system. PIFS also hosts international symposia, executive edu-cation programs and special events that foster dialogue and promote education on these issues. PIFS was founded in 1986, by Hal S. Scott, now Professor Emeritus of Harvard Law School. Over thirty years later, Hal Scott continues to lead PIFS.

This report was prepared by PIFS staff, including John Gulliver, Executive Director, Hillel Nadler, Senior Research Fellow, and Robert Greene, Senior Fellow. Jon Ondrejko and Almira Broome, Senior Research Fellows at the Committee on Capital Markets Regulation, also participated in research and drafting.

In addition, PIFS assembled a global advisory committee on equity market structure regulation, the members of which assisted in the preparation of this report by reviewing drafts and providing com-mentary and insight to our team. The members of the global advisory committee are listed on the next page.

The Program on International Financial Systems would like to thank Citadel Securities for supporting this research.

Global Advisory Committee

China: Mainland

Liuyi Pi Deputy Director of Market Supervision, China Securities Regulatory Commission

James Sha Senior Advisor, China Financial Futures Exchange Wang Xian Associate Dean, National Institute Financial Research, PBC School of Finance,

Tsinghua University; Former Deputy Director of Market Supervision, China Securities Regulatory Commission

China: Hong Kong Special Administrative Region

Douglas Arner Kerry Holdings Professor in Law, University of Hong Kong Anthony Neoh Former Chairman, Hong Kong Securities and Futures Commission Fanqi Nie Founder, BeeVest Securities

European Union

Jonathan Jachym Head of North America Regulatory Strategy Government Relations, London Stock Exchange Group

Tilman Lueder Head of the Securities Markets Unit, DG FISMA, European Commission Jakub Michalik Senior Officer, Corporate Affairs Department, European Securities and Markets

Authority Japan

Satoshi Ikeda Chief Sustainable Finance Officer and Director for Exchanges and FMIs Supervision, Japan Financial Services Agency

Hideki Kanda Emeritus Professor, University of Tokyo; Professor, Gakushuin University Law School

Takumi Shibata Former Chief Executive Officer, Nikko Asset Management United States

James Angel Associate Professor, Georgetown University McDonough School of Business Annette Nazareth Former Commissioner, Securities and Exchange Commission Michael Piwowar Former Commissioner, Securities and Exchange Commission Erik Sirri Professor of Finance, Babson College

Global Institutions

Gregory Babyak Global Head of the Regulatory and Policy Group, Bloomberg L.P. Hubert DeJesus Global Head of Electronic Trading and Market Structure, BlackRock Amy Hong Global Head of Market Structure – Equities & FICC, Securities Division, Goldman

Sachs Jamil Nazarali Global Head of Business Development, Citadel Securities

International Review of Equity Market Structure Regulation

Contents

1 Comparative Analysis of Equity Market Structure Regulation 1

a. Regulation of trading venues 1 b. Pre- and post-trade transparency: dark vs lit trading 4 c. Regulation of broker-dealers 5 d. Regulation of exchange fees 7 e. Tick-size regimes 9 f. Algorithmic and high-frequency trading 10 g. Volatility controls 12

2 Regulation of Equity Market Structure in China: Mainland 15

a. Regulatory framework 15 b. Trading venues 16 c. Best execution 24 d. Tick sizes 25 e. Algorithmic and high-frequency trading 25 f. Volatility controls 26

3 Regulation of Equity Market Structure in China: Hong Kong Special Administrative Region 27

a. Regulatory framework 27 b. Trading venues 29 c. Pre- and post-trade transparency 32 d. Best execution 33 e. Tick sizes 35 f. Algorithmic and high-frequency trading 35 g. Volatility controls 37

4 Regulation of Equity Market Structure in the European Union 39

a. Regulatory framework 39 b. Trading venues 43 c. Pre- and post-trade transparency 49 d. Pre-trade transparency: dark trading versus lit trading 55 e. Best execution 59 f. Tick sizes 63 g. Algorithmic and high-frequency trading 64 h. Volatility controls 68

5 Regulation of Equity Market Structure in Japan 70


6 Regulation of Equity Market Structure in the United States 83


Review of Equity Market Structure Regulation 1

The research staff of the Program on International Financial Systems (“PIFS”) has reviewed and

summarized the regulation of equity market structure in the People’s Republic of China (including

both the Mainland market and the Hong Kong Special Administrative Region),1 the European Un-

ion, Japan and the United States. The purpose of our study is to inform the public as to key simi-

larities and differences among the regulatory regimes in these five jurisdictions that collectively

represent approximately 90% of global stock trading.2 A review of our key findings as to the fol-

lowing regulatory issues is below: (1) regulation of trading venues; (2) pre- and post-trade trans-

parency; (3) regulation of broker dealers; (4) regulation of exchange fees; (5) tick-size regimes; (6)

algorithmic and high-frequency trading; and (7) volatility controls. Chapters two through six go

into further detail on these topics for each jurisdiction.

There are three types of trading venues for stocks.3 First, there are stock exchanges that match

buyers and sellers of stock and are self-regulatory organizations that are the primary listing venue

for public companies. Second, there are multilateral trading venues that also match buyers and

sellers but are not self-regulatory organizations and cannot be the primary listing venue for public

companies. And third, there are broker-dealer internalizers that do not match buyers and sellers,

but instead act as principals and execute customer orders against a broker-dealer’s own inventory

of stocks. Each is subject to its own regulatory requirements.

In Mainland China, exchanges are the only type of trading venue for publicly-listed stocks, as off-

exchange trading in these stocks is prohibited.4 Publicly-listed stocks can only trade on the pri-

mary listing exchange, so there is no competition among stock exchanges for trading volume.5

The Shanghai Stock Exchange (“SSE”) and the Shenzhen Stock Exchange (“SZSE”) are the only

national stock exchanges approved by the China Securities Regulatory Commission (“CSRC”).6 In

1 For ease of reference, this report refers to (i) the People’s Republic of China as “China”; (ii) the Hong Kong Special

Administrative Region of the People’s Republic of China as “Hong Kong”; and (iii) the rest of China as “Mainland China.” 2 World Federation of Exchanges, Annual Statistics Guide (2017), available at http://w.world-exchanges.org/home/in-

dex.php/statistics/annual-statistics. 3 For purposes of this summary, we use broadly applicable definitions such as trading venues and broker-dealers as

each jurisdiction that we reviewed has different terminology to refer to these entities. Our detailed outlines include

glossaries with specific definitions. 4 Securities Law of the People's Republic of China, Article 39 (2005) https://www.accaglobal.com/con-

tent/dam/acca/global/pdf/ChinaSecuritiesLaw2006.pdf. Brokers are required to route orders to exchanges and cannot

internalize them. China Securities Law Article 39 and Article 145. See also Article 111-112. See English version here:

https://www.accaglobal.com/content/dam/acca/global/pdf/ChinaSecuritiesLaw2006.pdf (p. 28). 5 WORLD BANK, People’s Republic of China: Financial Sector Assessment Program 279 (October 2017) http://docu-

ments.worldbank.org/curated/en/363291512541399092/pdf/121861-WP-P157065-PUBLIC-ADD-FSAP-SERIES-Finan-

cial-Sector-Assessment-Program-FSAP-China-FSAP-2017-DAR-IOSCO.pdf. 6 James Chen, Shanghai Stock Exchange (May 4, 2018) https://www.investopedia.com/terms/s/shanghai-stock-ex-

change.asp (“The Shanghai Stock Exchange (SSE) is… a nonprofit organization run by the China Securities Regulatory

Commission (CSRC).”); SHENZHEN STOCK EXCHANGE, About: Overview (last visited Apr. 12, 2019) http://www.szse.cn/Eng-

lish/about/overview/index.html (“Shenzhen Stock Exchange (SZSE), established on 1st December, 1990, is a self-regu-

lated legal entity under the supervision of China Securities Regulatory Commission (CSRC).”).

2 Review of Equity Market Structure Regulation

July 2019, the SSE launched a Science and Technology Innovation Board (“STAR Board”) with

more lenient trading regulations but restricted investor access.7 We note that there are other trad-

ing venues for stocks that are not publicly listed, including: (i) the National Equities Exchange and

Quotations (“NEEQ”),8 and (ii) regional trading platforms for non-public companies,9 both of

which are restricted to qualified investors.10 However, in our report, we focus on the trading of

publicly-listed stocks, because they represent the vast majority of global stock market capitaliza-

tion and trading volume.

In Hong Kong and Japan, off-exchange trading is permitted on multilateral trading facilities and

through broker-dealer internalization.11 In Hong Kong, the Hong Kong Stock Exchange (“HKEx”)

is the only exchange group approved by the Securities and Futures Commission of Hong Kong

(“SFC”);12 and in Japan, the Tokyo Stock Exchange (“TSE”) is the only non-regional exchange ap-

proved by the Financial Services Authority (“FSA”).13

7 See infra notes 134-140 and accompanying text. Only investors with over 500,000 RMB in investible assets and more

than two years of trading experiences are allowed to buy or sell stocks listed on SSE’s STAR Board. See infra notes 139-

140 and accompanying text. 8 NATIONAL EQUITIES EXCHANGE & QUOTATIONS, Introduction (last accessed Sept. 26, 2019), http://www.neeq.com.cn/en/ser-

vices/investors_home/brief_intro.html (“Companies thereon are non-listed public companies whose shareholders may

be more than 200 people and shares can be transferred openly.”); WORLD BANK, People’s Republic of China, Financial

Sector Assessment Program: Detailed Assessment of Observance 12 (Oct. 2017), http://documents.worldbank.org/cu-

rated/en/860161518601604502/pdf/DAR-Securities.pdf. 9 WORLD BANK, People’s Republic of China, Financial Sector Assessment Program: Detailed Assessment of Observance 12-

13 (Oct. 2017), http://documents.worldbank.org/curated/en/860161518601604502/pdf/DAR-Securities.pdf; Weiping

He, The Regulation of Securities Markets in China 227, SPRINGER (2018). 10 See Bloomberg, China's Third Stock Exchange Readies for Shanghai-Style Trading (January 2018) (explaining that

“[u]nlike the Shanghai and Shenzhen stock exchanges, NEEQ has an investor threshold of two years’ experience in

securities investing and 5 million yuan worth of securities in assets”), https://www.bloomberg.com/news/articles/2018-

01-09/china-s-third-stock-exchange-readies-for-shanghai-style-trading. 11 In Hong Kong, multilateral trading facilities are regulated as “automated trading services.” SECURITIES AND FUTURES COM-

MISSION, Consultation Paper Concerning the Regulation of Alternative Liquidity Pools, 4 (Feb. 27, 2014)

https://www.sfc.hk/edistributionWeb/gateway/EN/consultation/doc?refNo=14CP3. In Japan, they are regulated as

“proprietary trading systems.” Agenda for competition among trading venues and alternative trading platforms, FINANCIAL

MARKETS DIVISION, FINANCIAL SERVICES AGENCY (JAPAN) (June 15, 2016), available at

https://www.fsa.go.jp/en/news/2016/20160513-1/03.pdf. 12 SECURITIES AND FUTURES ORDINANCE, A1241, https://www.sfc.hk/web/EN/pdf/laws/sfo/1/Ordinance/5%20of%202002.pdf. 13 As of April 2019, there were 3,665 companies listed on the TSE versus 292 on the Nagoya Stock Exchange (of which

only 66 were listed exclusively), 109 on the Fukuoka Stock Exchange (of which 26 were listed exclusively), and 57 on the

Sapporo Securities Exchange (of which 16 were listed exclusively). Japan Exchange Group (JPX), Number of Listed Com-

panies/Shares (Apr. 12, 2019), available at https://www.jpx.co.jp/english/listing/co/index.html (TSE); Nagoya Stock Ex-

change, Listed Companies (Apr. 16, 2019), available at http://www.nse.or.jp/e/meigara/stockcount/; Fukuoka Stock Ex-

change, About Us: Introduction, https://www.fse.or.jp/english/about/index.php; Sapporo Securities Exchange, About

Sapporo Securities Exchange (January 1, 2019), available at https://www.sse.or.jp/about.

http://www.neeq.com.cn/en/services/investors_home/brief_intro.html


http://documents.worldbank.org/curated/en/860161518601604502/pdf/DAR-Securities.pdf



https://www.bloomberg.com/news/articles/2018-01-09/china-s-third-stock-exchange-readies-for-shanghai-style-trading

https://www.bloomberg.com/news/articles/2018-01-09/china-s-third-stock-exchange-readies-for-shanghai-style-trading


In the European Union14 and United States,15 off-exchange trading is permitted on multilateral

trading facilities and through broker-dealer internalization. There are also multiple stock ex-

changes that have been approved by the competent authorities in the European Union16 and by

the Securities and Exchange Commission (“SEC”) in the United States.17 A stock exchange in the

United States and European Union can trade stocks that are listed on another exchange, so these

stock exchanges compete with each other for trading volume.

We note that the jurisdictions that permit off-exchange trading require that the operator of such

trading venues be registered with regulators and subject to certain risk controls and disclosure

requirements.18

Trading Venues: Summary Chart

Jurisdiction Exchanges Other Trading Venues Broker-Dealer

Internalization

European Union Multiple Exchanges

(including LSE, Euronext, etc.)

Regulated as Multilateral

Trading Facilities

Permitted

Hong Kong One Exchange (HKEx) Regulated as Automated

Trading Services

Permitted

Japan One National Exchange (TSE),

Three Regional Exchanges

Regulated as Proprietary

Trading Systems

Permitted

Mainland China Two Exchanges (SSE, SZSE) Prohibited Prohibited

United States Multiple Exchanges

(including NYSE, NASDAQ, etc.)

Regulated as Alternative

Trading Systems

Permitted

14 See the definition of ‘execution venue’ in RTS 27, Recital 2. (The full details and citations of all the European Union

sources can be found in the summaries accompanying this outline.) 15 In the United States, multilateral trading facilities are regulated as “alternative trading systems.” Regulation of Ex-

changes and Alternative Trading Systems, Exchange Act Release No. 40760, File No. S7-12-98 (Dec. 8, 1998)

https://www.sec.gov/rules/final/34-40760.txt. 16 MiFID 2 Directive, Article 44. 17 15 U.S.C. § 78f (2010). United States stock exchanges include the New York Stock Exchange, Nasdaq, Bats Global

Markets, the Chicago Stock Exchange, and the National Stock Exchange, among others. FINANCIAL INDUSTRY REGULATORY

AUTHORITY, NYSE, Nasdaq and...? Get to Know the U.S.'s Stock Exchanges (Aug. 17, 2016) http://www.finra.org/inves-

tors/nyse-nasdaq-and-get-know-uss-stock-exchanges-part-1. 18 In the United States, alternative trading systems must be operated by a registered broker-dealer. Regulation of Ex-

changes and Alternative Trading Systems, Exchange Act Release No. 40760, File No. S7-12-98 (Dec. 8, 1998)

https://www.sec.gov/rules/final/34-40760.txt. In Japan, proprietary trading systems must be operated by financial in-

struments business operators regulated by the Financial Services Agency and the Securities Exchange and Surveillance

Commission. INTERNATIONAL MONETARY FUND, MONETARY AND CAPITAL MARKETS DEPARTMENT (IMF), Japan: IOSCO Objectives

and Principles of Securities Regulation— Detailed Assessment of Implementation, IMF Country Report No. 12/230, 7

(August 2012). In Hong Kong, only licensed corporations can operate automated trading services. SECURITIES AND FUTURES

COMMISSION, Do you need a licence or registration? (Feb. 11, 2019) https://www.sfc.hk/web/EN/regulatory-functions/in-

termediaries/licensing/do-you-need-a-licence-or-registration.html#1. For the EU provisions on the need for ‘invest-

ment firms’ authorization, see MiFID 2 Directive, Recital 37; Articles 5 and 6; Annex I, Section A; Article 16.


“Lit” trades are executed on venues with pre-trade transparency, meaning that orders to buy and

sell a stock (including size and price information) are publicly displayed before execution of the

trade. Trades that take place in the “dark” are simply trades that are executed on venues without

pre-trade transparency. We note that all five jurisdictions that we reviewed require post-trade

transparency, meaning that once a trade is executed the size and price information of the trade

must be publicly reported.19

Dark trading is prohibited in Mainland China.20 In Hong Kong, the HKEx prohibits dark trading on

the exchange,21 but multilateral trading venues and broker-dealer internalizers may engage in

dark trading.22 In Japan, the FSA prohibits dark trading on the Tokyo Stock Exchange (“TSE”), but

multilateral trading venues and broker-dealer internalizers may engage in dark trading.23 In the

European Union, exchanges and multilateral trading venues may engage in dark trading, however

dark trading on both venues is subject to limits. These limits are based on the total amount of

dark trading in a stock per venue and the total amount of dark trading in a stock across all trading

venues.24 For quotes up to and including the standard market size, broker-dealer internalizers

(“systematic internalisers” in the EU) must: (i) publicly publish pre-trade quotes for shares with a

liquid market and (ii) make pre-trade quotes for shares without a liquid market available to clients

upon request.25 Finally, in the United States, exchanges, multilateral trading venues and broker-

dealer internalizers may engage in dark trading.26 However, multilateral trading venues in the

United States must publicly display orders in a specific stock if they display orders to participants

19 U.S. SEC. & EXCH. COMM’N, Concept Release on Equity Market Structure, Exchange Act Release No. 61358, File No. S7-

02-10, 75 FED. REG. 3594, 3600 (proposed Jan. 21, 2010); International Monetary Fund. Monetary and Capital Markets

Department, People’s Republic of China–Hong Kong Special Administrative Region : Financial Sector Assessment Program-

IOSCO Objectives and Principles of Securities Regulation-Detailed Assessment of Observance, Country Report No. 14/205,

212 (July 16, 2014) https://www.imf.org/en/Publications/Publications-By-Author?author=International+Mone-

tary+Fund.++Monetary+and+Capital+Markets+Department&name=International%20Mone-

tary%20Fund.%20%20Monetary%20and%20Capital%20Markets%20Department; Japan Cabinet Office Ordinance on Fi-

nancial Instruments Business Table 1, Articles 74-75. In China, as noted earlier, all trading takes places on exchanges.

For the EU, see MiFIR, Articles 6 and 20; RTS 1. 20 During the continuous auction, the Exchanges must disclose to Exchange members in real-time the five lowest offer

prices and five highest bid prices (and respective quantities) for listed securities. Exchange Trading Rules Chapter V, 5.2. 21 International Monetary Fund. Monetary and Capital Markets Department, People’s Republic of China–Hong Kong

Special Administrative Region : Financial Sector Assessment Program-IOSCO Objectives and Principles of Securities

Regulation-Detailed Assessment of Observance, Country Report No. 14/205, 212 (July 16, 2014). 22 IMF, Hong Kong: IOSCO Objectives and Principles of Securities Regulation at 214. 23 INTERNATIONAL MONETARY FUND, MONETARY AND CAPITAL MARKETS DEPARTMENT (IMF), Japan: IOSCO Objectives and Principles

of Securities Regulation— Detailed Assessment of Implementation, IMF Country Report No. 12/230, 7 (August 2012). 24 MiFID 2 Regulation, Article 5. 25 MiFIR 1, Article 14. See also Ulrich Nogel, ‘MiFID 2 double volume caps – the end of dark trading?, 44 Automated Trader

Magazine (2018) available at http://www.automatedtrader.net/articles/strategies/158441/mifid-2-double-volume-

caps-_-the-end-of-dark-trading. 26 OECD, Changing business models of stock exchanges and stock market fragmentation, in OECD Business and Finance

Outlook 2016, 127, 130-31 (2016), available at https://www.oecd.org/daf/ca/BFO-2016-Ch4-Stock-Exchanges.pdf.

https://www.oecd.org/daf/ca/BFO-2016-Ch4-Stock-Exchanges.pdf


on their trading venues and execute more than 5% of total trading volume across all trading ven-

ues in that stock – though in practice, no trading venues exceed that threshold.27

Dark Trading: Summary Chart

Jurisdiction

Dark Trading

Exchanges Other Trading Venues Broker-Dealer

Internalizers

European Union Permitted with Limits Permitted with Limits Permitted above SMS

Hong Kong Prohibited Permitted Permitted

Japan Prohibited Permitted Permitted

Mainland China Prohibited Prohibited Prohibited

United States Permitted Permitted with Limits Permitted

Broker-dealers stand at the heart of the equity market structure of each of the five jurisdictions,

as they are responsible for routing investor orders to trading venues for execution. Although each

jurisdiction requires that broker-dealers register with a regulatory agency,28 each jurisdiction has

different requirements as to how broker-dealers should handle client orders--the duty of best

execution--and the related disclosures that they must provide their clients as to order routing

decisions and execution quality. These requirements are critical for an efficient equity market

structure, as they enable investors to identify the broker-dealers that are most likely to provide

them with the best terms of execution (such as best price, largest size, fastest execution).

In Mainland China and Japan, there is limited regulatory guidance as to the duty of best execution.

The CSRC requires that broker-dealers treat their clients fairly and route client orders to the rele-

vant exchange according to the instruction of the clients.29 In Japan, broker-dealers must adopt a

policy and method for executing orders from customers under the best terms and conditions, but

27 Requirements for Alternative Trading Systems, 17 C.F.R. § 242.301(b)(3). 28 In the Unites States, most broker-dealers must register with the SEC. U.S. SEC. & EXCH. COMM’N, Guide to Broker-Dealer

Registration (April 2008) https://www.sec.gov/reportspubs/investor-publications/divisionsmarketreg-

bdguidehtm.html#I. In Japan, a firm seeking to provide securities services must register as a “financial instruments

business operator.” INTERNATIONAL MONETARY FUND, Japan: Financial Sector Assessment Program: Technical Note – Regu-

lation and Supervision of Securities Firms (Sept. 2017) https://www.imf.org/~/media/Files/Publica-

tions/CR/2017/cr17284.ashx. In Hong Kong, firms that deal in or advise on securities must become “licensed corpora-

tions” under the Securities and Futures Ordinance. SECURITIES AND FUTURES COMMISSION, Do you need a license or registra-

tion? (Feb. 11, 2019) https://www.sfc.hk/web/EN/regulatory-functions/intermediaries/licensing/do-you-need-a-li-

cence-or-registration.html#1. In the People’s Republic of China, securities companies are regulated by the China Secu-

rities Regulatory Commission (CSRC). CHINA SECURITIES REGULATORY COMMISSION, About CSRC: Introducing the CSRC (Nov.

30, 2008) http://www.csrc.gov.cn/pub/csrc_en//about/intro/200811/t20081130_67718.html. In the EU, investment firms

must be authorized in their Member States for the investment activity they are performing, MiFID 2 Directive Articles 5

and 6; Annex I, Section A; Article 16. 29 China Securities Law Article 39 and Article 145. See also Article 111-112. See English version here: https://www.ac-

caglobal.com/content/dam/acca/global/pdf/ChinaSecuritiesLaw2006.pdf (p. 28)

http://www.csrc.gov.cn/pub/newsite/flb/flfg/flxzsf/201312/t20131205_239325.html.


no further guidance is provided as to what is meant by best terms and conditions.30 As a result,

execution quality is primarily ensured by customer monitoring and selection of their broker-

dealer.

The duty of best execution is more detailed in Hong Kong, the European Union and the United

States. In Hong Kong, the SFC requires that broker-dealers execute client orders on the best avail-

able terms, which include (1) price, (2) cost, (3) speed of execution, (4) likelihood of execution, (5)

speed of settlement, (6) likelihood of settlement, and (7) the size and nature of an order.31 In the

E.U., broker-dealers must take “all sufficient steps” to obtain the best possible results for their

clients,32 taking into account price, costs, speed, likelihood of execution and settlement, size, na-

ture or any other consideration relevant to the execution of the order.33 In the U.S., the Financial

Industry Regulatory Association (“FINRA”), the self-regulatory authority for U.S. broker-dealers,

requires broker-dealers to “use reasonable diligence to ascertain the best market for the subject

security and buy or sell in such market so that the resultant price to the customer is as favorable

as possible under prevailing market conditions.”34

As noted earlier, each of the five jurisdictions requires post-trade transparency. Post-trade trans-

parency is relevant to the duty of best execution as it provides investors the ability to assess

whether the price and terms of execution received for their orders is generally consistent with

their expectations when they submitted their orders to the broker-dealer.35 Each of the five juris-

dictions that we reviewed also has additional requirements as to record-keeping and disclosure

requirements for broker-dealer order routing decisions and execution quality that provides inves-

tors with further insight as to their broker-dealer’s duty of best execution.

In Mainland China, these requirements are limited, as broker-dealers are solely required to “keep

under safe custody the records of their clients’ orders and their order routing activities.”36 In Japan,

broker-dealers must disclose their best execution policy to clients; however there are not specific

requirements as to order routing decisions (how a broker-dealer chooses among trading venues)

or execution quality achieved on a specific trading venue or across all trading venues.37 In Hong

Kong, broker-dealers are required to adopt policies and procedures that address disclosure to

30 See FIEA Article 40-2. We note that our analysis focuses on the regulations and guidance in place for broker-dealers

duty of best execution. We do not focus on the enforcement practices of the regulatory agencies. 31 SECURITIES AND FUTURES COMMISSION, Circular to Licensed Corporations on Best Execution (Jan. 30, 2018)

https://www.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=18EC7. 32 MiFID 2 Directive, Article 27. 33 This is subject to any specific instruction from the client to execute in accordance with that instruction. 34 FINRA Rule 5310. 35 In the European Union, post-trade transaction reporting is considered also relevant to preventing market abuse,

Explanatory Memorandum to the Data Reporting Services Regulation 2017 (SI 699/2017), paragraph 7.7. 36 Trading Rules, Chapter III, 3.1.3 37 See Shohei Kuga, The Growing Significance of TCA in Japan, Fidessa (June 2017), available at

https://www.fidessa.com/jp/newsletter/issue010/the-growing-significance-of-tca-in-japan; Where does Asia stand on

compliance, best execution and TCA in 2019?, Bloomberg Professional Services (January 20, 2019), available at

https://www.bloomberg.com/professional/blog/asia-stand-compliance-best-execution-tca-2019/


clients of best execution arrangements including carve outs and the exclusive use of affiliates,

connected parties and third parties,38 including any payments for order flow.39

The disclosure requirements related to best execution in the European Union40 and United States41

go significantly further than the other jurisdictions, as broker-dealers must disclose the trading

venues that they route to and how they make such routing decisions, including quantitative exe-

cution quality considerations.42 In the United States, payment for order flow arrangements must

be disclosed.43 In the European Union, payment for order flow arrangements are prohibited.44

Finally, in the European Union45 and the United States,46 trading venues are required to disclose

quantitative metrics as to their execution quality (e.g. execution prices on the trading venue as

compared to the best price available across all trading venues) that further facilitate investors’

ability to assess the execution quality achieved by their broker-dealers.

In each of the five jurisdictions that we reviewed, the majority of stock trades are executed on

exchanges, particularly in Asian jurisdictions where more than 90% of stock trades are executed

on exchanges.47 We therefore focus our attention on the regulation of the fees that exchanges

may charge broker-dealers for accessing an exchange, executing client orders or for market data

that can only be accessed from an exchange. We generally find that the regulatory authority in

each jurisdiction must approve exchange fees but have varying standards of review.

In Mainland China, the CSRC together with the National Development and Reform Commission

have the express authority to set fees at stock exchanges.48 Regarding criteria used to determine

38 SECURITIES AND FUTURES COMMISSION, Code of Conduct for Persons Licensed by or Registered with the Securities and Futures

Commission, General Principle 1 and sections 10.1 and 13.1 (Nov. 25, 2018) https://www.sfc.hk/web/EN/assets/compo-

nents/codes/files-current/web/codes/code-of-conduct-for-persons-licensed-by-or-registered-with-the-securities-

and-futures-commission/code-of-conduct-for-persons-licensed-by-or-registered-with-the-securities-and-futures-

commission.pdf (“HK Code of Conduct”); SECURITIES AND FUTURES COMMISSION, Circular to licensed corporations on best

execution (Jan. 30, 2018)

https://www.hkma.gov.hk/media/eng/doc/key-information/guidelines-and-circular/2018/20180209e1a1.pdf. 39 HK Code of Conduct, 13.1 40 RTS 27 and RTS 28. 41 17 C.F.R. § 242.606(a)(1)(iii) (2005); U.S. SEC. & EXCH. COMM’N, SEC Adopts Rules That Increase Information Brokers Must

Provide to Investors on Order Handling (Nov. 2, 2018) https://www.sec.gov/news/press-release/2018-253. 42 RTS 28. 43 17 C.F.R. § 242.606(a)(1)(iii) (2005). 44 MiFID 2 Directive, Article 27(2). 45 RTS 27. 46 See generally 17 C.F.R. § 242.605 (2005). 47 See, e.g., SECURITIES AND FUTURES COMMISSION, Report on the Thematic Review of Alternative Liquidity Pools in Hong Kong,

4 (Apr. 9, 2018) https://www.sfc.hk/web/EN/files/IS/publications/ALP%20Report%20(EN).pdf; FINANCIAL MARKETS DIVISION,

FINANCIAL SERVICES AGENCY (JAPAN), Agenda for competition among trading venues and alternative trading platforms, (June

15, 2016), available at https://www.fsa.go.jp/en/news/2016/20160513-1/03.pdf (as of 2016, approximately 90% of trad-

ing in listed stocks occurred on the TSE and 5% of trading occurred on PTS). 48 IOSCO, Trading Fee Models and their Impact on Trading Behaviour (Dec. 2013) http://www.csrc.gov.cn/pub/csrc_en/af-

fairs/AffairsIOSCO/201402/P020140213529122654245.pdf.


fee levels, the CSRC has stated that “market size and environment” have been factors.49 In Hong

Kong, exchange fees must be specified in rules approved by the SFC.50 In making its decision on

fee rules, the SFC must take into account the level of competition, if any, in Hong Kong for the

matter for which the fee is to be imposed and the fees, if any, imposed by another recognized

exchange controller or recognized exchange company or any similar entity outside Hong Kong

for equivalent matters.51

In Japan, exchanges are required to obtain FSA approval for the fees that they charge.52 Exchanges

are also required to perform benchmarking analysis and/or impact analysis, and the FSA must

determine whether the structure of the model or the fee charge is fair or unduly discriminatory.53

The FSA evaluates the reasonableness of exchange fees by considering service provided vs. fees

charged, operational cost, value added, comparable fees of other trading venues and competition

factors.54

In the European Union, exchange fees must be transparent, fair and non-discriminatory as deter-

mined by the competent authority in the E.U. Member State.55 Generally, exchanges must charge

broker-dealers similar fees for similar services.56 With respect to market data fees, exchanges must

provide market data on a “reasonable commercial basis.”57 As a result, market data prices must

be: (i) based on costs of producing and disseminating such data, including a reasonable margin;

(ii) offered on a non-discriminatory basis to all clients; (iii) charged according to the individual

end-user’s use; and (iv) available without being bundled with other services.58

In the United States, exchange rules must provide for the equitable allocation of reasonable fees

and other charges among its broker-dealer members, not permit unfair discrimination and not

impose any unnecessary burden on competition.59 Exchange fees do not require pre-approval and

are effective upon filing with the SEC,60 but the SEC may immediately temporarily suspend pro-

posed fees if they appear inconsistent with the requirements of the Exchange Act and institute

49 CHINA SECURITIES AND REGULATORY COMMISSION, Substantial Decrease on A-share Transaction-related Fees (April 30, 2012)

http://www.csrc.gov.cn/pub/csrc_en/newsfacts/release/201205/t20120508_209698.html 50 Hong Kong Securities and Futures Ordinance, Section 76. 51 Hong Kong Securities and Futures Ordinance, Section 76. 52 IOSCO, Trading Fee Models and their Impact on Trading Behaviour: Final Report, FR12/13 (December 2013). 53 IOSCO, Trading Fee Models and their Impact on Trading Behaviour: Final Report, FR12/13 (December 2013). 54 IOSCO, Trading Fee Models and their Impact on Trading Behaviour: Final Report, FR12/13 (December 2013). 55 MiFID 2 Directive, Article 48(9) 56 RTS 10, 330. 57 EUROPEAN SECURITIES AND MARKETS AUTHORITY, Consultation Paper: MiFID II/MiFIR Review Report on the Development in

Prices for Pre- and Post-Trade Data and on the Consolidated Tape for Equity Instruments, 15 (July 12, 2019),

https://www.esma.europa.eu/sites/default/files/library/esma70-156-1065_cp_mifid_review_report_cost_of_mar-

ket_data_and_consolidated_tape_equity.pdf. 58 Id. 59 Section 6 of the Securities Exchange Act of 1934. 60 In October 2019, the SEC proposed a rule rescinding the current exception that allows exchange fee changes to

become immediately effective upon filing. U.S. SEC. & EXCH. COMM’N, Rescission of Effective-Upon Filing Procedure for

NMS Plan Fee Amendments, Exchange Act Release No. 34-87193 (Oct. 1, 2019), https://www.sec.gov/rules/pro-

posed/2019/34-87193.pdf.


proceedings to determine whether the fee should be approved.61 In addition, the consolidated

market data fees charged by exchanges must be fair and reasonable.62 Further, there is an explicit

cap on “access” fees (30 cents/100 shares) that exchanges can charge for publicly displayed or-

ders.63 In April 2019, the SEC launched a transaction fee pilot to explore further reducing the cap

on access fees.64 Although the pilot remains on hold pending the resolution of legal challenges

raised by exchanges,65 the data collection associated with it has commenced.

A minimum tick-size refers to the smallest pricing increment at which a trading venue can display

(quote) order interest to buy or sell a stock. Regulators and/or trading venues impose minimum

tick sizes to encourage displayed liquidity at specific minimum spreads between the price bid and

offered for stocks. Minimum tick sizes may be based on the fundamental supply and demand for

a stock, on a stock’s price, or on a commonly used price measurement such as 1/100th of a U.S.

dollar.

In Mainland China, the CSRC must approve tick-size rules on the Chinese exchanges.66 On the

Shanghai and Shenzhen Stock Exchanges, the minimum tick sizes are RMB 0.01.67 In Hong Kong,

the SFC must approve the tick-size rules on the HKEx.68 Tick sizes on the HKEx vary based on share

price, with lower-priced stocks having smaller tick sizes.69 Operators of multilateral trading venues

in Hong Kong can determine their own tick-sizes,70 but they remain subject to the SFC’s general

61 Section 19(b)(3) of the Securities Exchange Act of 1934; 15 U.S.C. § 78s(b)(3)(A), (C) (setting forth how fee-related rules

are effective immediately upon filing, but the SEC can summarily suspend the rule in order to institute proceedings to

determine whether it should be approved). 62 See generally 15 U.S.C. § 78k–1 (2012). See also Regulation NMS, Exchange Act Release No. 51808, 70 Fed. Reg. 37496,

37560, 37567 (Jun. 29, 2005) https://www.sec.gov/rules/final/34-51808fr.pdf. 63 Access to Quotations, 17 C.F.R. § 242.610. 64 U.S. SEC. & EXCH. COMM’N, SEC Adopts Transaction Fee Pilot for NMS Stocks (Dec. 2018)

https://www.sec.gov/news/press-release/2018-298. See also U.S. SEC. & EXCH. COMM’N, Transaction Fee Pilot for NMS

Stocks, Exchange Act Release No. 34-84875 (effective April 22, 2019) https://www.sec.gov/rules/final/2018/34-

84875.pdf. 65 Hazel Bradford, SEC puts transaction fee pilot on hold during court challenges, PENSIONS & INVESTMENTS (Mar. 29, 2019),

https://www.pionline.com/article/20190329/ONLINE/190329881/sec-puts-transaction-fee-pilot-on-hold-during-

court-challenges. 66 Articles 103 and 118 of the Securities Law, Article 15 of the Measures, and Articles 15 to 19 of the Interim Measures

for the Administration of National Equities Exchange and Quotations Co., Ltd. (NEEQ Interim Measures) See http://doc-

uments.worldbank.org/curated/en/363291512541399092/pdf/121861-WP-P157065-PUBLIC-ADD-FSAP-SERIES-Finan-

cial-Sector-Assessment-Program-FSAP-China-FSAP-2017-DAR-IOSCO.pdf (p. 279) (“Stock exchanges... must obtain the

CSRC’s approval to formulate or amend their constitutions or rules and regulations on listing, trading, and member

management”). 67 Trading Rules Chapter III, 3.3.13 (Shenzhen) and 3.4.11 (Shanghai). 68 Rules of recognized exchange companies are only effective upon approval by the SFC. Securities and Futures Ordi-

nance, Section 24. 69 DEUTSCHE BANK, Global Market Structure: Guide to Global Equity Exchanges (Feb. 2019) https://www.auto-

bahn.db.com/equity-market-guide/mktgd/exchanges.html. 70 See, e.g., CREDIT SUISSE, Asia Pacific Crossfinder User Guidelines (2018) https://www.credit-suisse.com/me-

dia/ib/docs/investment-banking/client-offering/crossfinder-user-guidelines-2018.pdf (“Crossfinder internal Tick Size:

Half of HKEx tick size”); MORGAN STANLEY HONG KONG SECURITIES LIMITED, ALP Guidelines for MS POOL for the Hong Kong


regulatory authority and ability to impose conditions on their licenses.71 In Japan, the FSA must

approve the tick-size rules on Japanese exchanges.72 Tick sizes on the TSE vary based on share

price, with lower-priced stocks having smaller tick sizes.73 Operators of multilateral trading venues

can determine their own tick-sizes subject to the approval of the regulatory authority.74

In the European Union, tick sizes must be based on the liquidity of a stock as determined by the

average daily number of transactions in that stock on the most relevant market.75 In the United

States, the SEC requires that stock exchanges and multilateral trading venues adopt a minimum

tick size of $0.01 for all stocks with a price above $1.00.76

In modern equity markets, aspects of the trading process that were traditionally done manually,

such as execution and order-routing, are now automated. Algorithmic trading—trading in which

computers are involved in making trading decisions with limited human involvement—has be-

come increasingly common.77 High frequency trading (“HFT”) refers to a subset of algorithmic

trading that relies on processing information from trading venues and entering orders at trading

venues at high speed. Accordingly, HFT is characterized by the use of special infrastructure to

minimize latencies—the time it takes to send data to a particular end point (and potentially back

again).78

HFT strategies fall into three basic categories that have always existed in equity markets: First,

market making which involves providing liquidity to the market by maintaining limit orders on

both sides of trades. Market makers must be able to quickly assess changes in supply and demand

for stocks and promptly update the prices at which they are willing to buy and sell. Second, HFT

strategies also include arbitrage strategies, whereby arbitrageurs identify price discrepancies that

arise between portfolios of assets or the same assets on different trading venues and conduct

trades that bring those prices back in line. Third, directional HFT strategies involve trading rapidly

Market (Mar. 2018) https://www.morganstanley.com/institutional-sales/hkdp-guidelines-mspool-mar2018.pdf (“MS

POOL accepts orders at full or half the SEHK standard tick sizes.”). 71 SECURITIES AND FUTURES COMMISSION, Consultation Paper concerning the Regulation of Alternative Liquidity Pools (Feb. 27,

2014) https://www.hksfa.org/upload/menu_content_detail/original/369866376630.pdf (“The current policy of the SFC is

to impose conditions on the licenses of ALP operators pursuant to section 116(6) of the SFO[.]”). 72 An exchange cannot change its operational rules without the approval of the FSA. See FIEA Article 149. 73 Japan Exchange Group (JPX), Trading Rules of Domestic Stocks: Tick Size (December 1, 2015), available at

https://www.jpx.co.jp/english/equities/trading/domestic/07.html. 74 To obtain authorization to operate a proprietary trading system, a firm must, among other things, adopt a price

formation method ensuring “that public interest and investor protection are maintained.” INTERNATIONAL MONETARY FUND,

Japan: Financial Sector Assessment Program: Technical Note – Regulation and Supervision of Securities Firms 30 (Sept.

2017) https://www.imf.org/en/Publications/CR/Issues/2017/09/18/Japan-Financial-Sector-Assessment-Program-Tech-

nical-Note-Regulation-and-Supervision-of-45262. 75 RTS 1 (as amended) and RTS 11. The tick size regime also applies to broker-dealer internalizers (Commission Dele-

gated Regulation (EU) 2019/442 of 12 December 2018). 76 17 C.F.R. § 242.612(a) (2005). 77 See Terrence Hendershott, Charles M. Jones, and Albert J. Menkveld, Does Algorithmic Trading Improve Liquidity?,

66:1 J. of Fin. 1, 2 (February 2011). 78 See Maureen O’Hara, High frequency market microstructure, 116:2 J. of Fin. Econ. 257, 258-60 (2015).


as new information enters the market, which helps make the price discovery process more efficient

and improves the accuracy of stock prices.79 HFT strategies typically feature a high volume of

orders (which, in line with the strategies described, may be revised or cancelled shortly after sub-

mission) and very low average profits per trade. They also usually involve ending the trading day

with as relatively neutral or flat risk a position as possible (that is, not carrying significant, un-

hedged positions overnight).80

The prevalence of HFT strategies varies cross jurisdictions. HFT is common in the United States,

accounting for approximately 50% of equity trading volume.81 Similarly, approximately 40-50%

of trades on the Tokyo Stock Exchange, Japan’s primary equity trading venue, are placed through

servers co-located with the exchange’s trading system.82 Estimates of trading volumes in the Eu-

ropean Union and Hong Kong are less reliable but generally show that HFT strategies constitute

a significant percentage of overall trading volume.83 In Mainland China, by contrast, investors em-

ploy various forms of algorithmic trading, but the use of standard HFT strategies is limited by

certain market structure barriers. The cost of trading in Mainland China is relatively high and net-

work connection latency levels on Chinese exchanges are not conducive to rapid trading. In addi-

tion, equity trading in Mainland China is subject to settlement regulations that forbid selling se-

curities until they are settled—typically on a T+1 basis.84

The jurisdictions reviewed in this report also differ with respect to how they regulate algorithmic

trading and HFT. Mainland China, for example, does not directly regulate either.85

Hong Kong regulates all electronic trading of securities and futures, including algorithmic trading,

but it does not specifically regulate HFT; however, the regulatory requirements that apply gener-

ally to algorithmic traders apply to investors that employ HFT strategies. The SFC requires that

firms engaged in electronic trading, or firms that provide electronic trading platforms, adopt risk

79 See STAFF OF THE DIVISION OF TRADING AND MARKETS, S. SEC. & EXCH. COMM’N, Equity Market Structure Literature Review –

Part II: High Frequency Trading, 7-8 (March 18, 2014), available at https://www.sec.gov/marketstructure/re-

search/hft_lit_review_march_2014.pdf. 80 See id at 4. 81 NASDAQ, High Frequency Trading (last accessed April 30, 2019) https://www.nasdaq.com/investing/glossary/h/high-

frequency-trading (“It is estimated that 50 percent of stock trading volume in the U.S. is currently being driven by

computer-backed high frequency trading.”); Gregory Meyer, Nicole Bullock and Joe Rennison, How high frequency trad-

ing hit a speed bump, Financial Times (January 1, 2018), available at https://www.ft.com/content/d81f96ea-d43c-11e7-

a303-9060cb1e5f44.. 82 See FINANCIAL SERVICES AGENCY, Report by the Working Group on Financial Markets under the Financial System Council,

14 (December 22, 2016), available at https://www.fsa.go.jp/en/refer/councils/singie_kinyu/20170509/03.pdf. 83 See EUROPEAN SECURITIES AND MARKETS AUTHORITY, High-frequency trading activity in EU equity markets, ESMA Economic

Report, Number 1 (2014) (reporting that HFT accounted for between 30-49% of all trades and 58-76% of all orders on

EU equity markets in May 2013); Robert J. Kauffman, Yuzhou Hu and Dan Ma, Will high-frequency trading practices

transform the financial markets in the Asia Pacific Region?, 1 Financial Innovations 1, 9 (2015) (citing an SFC report that

roughly 20% of all equity trading volume in 2012 was represented by HFT). 84 See Section 2.e. 85 See id.

https://www.sec.gov/marketstructure/research/hft_lit_review_march_2014.pdf

https://www.sec.gov/marketstructure/research/hft_lit_review_march_2014.pdf

https://www.ft.com/content/d81f96ea-d43c-11e7-a303-9060cb1e5f44

https://www.ft.com/content/d81f96ea-d43c-11e7-a303-9060cb1e5f44

https://www.fsa.go.jp/en/refer/councils/singie_kinyu/20170509/03.pdf


controls and provide clients with adequate disclosure regarding the risks of electronic trading.86

The SFC also imposes specific testing and recordkeeping requirements on algorithmic traders.87

In the European Union, algorithmic traders must notify regulators, must put in place extensive risk

controls, and must comply with comprehensive recordkeeping requirements. Firms that employ

market making algorithms must also agree to do so on a continuous basis. HFT, defined as a

subset of algorithmic trading that is intended to minimize latency and involves high-message

rates, such as orders, quotes and cancellations, is subject to additional regulations.88

Japan has adopted regulations that apply specifically to HFT. Whether an investor is considered

to engage in HFT depends on whether their trading system is located close to a trading venue.

HFT firms are required to register with the FSA, provide the FSA with trading information and

adopt risk controls specified in supervisory guidelines.89

In the United States, firms engaged in algorithmic trading or HFT are either regulated as broker-

dealers or, in the case of trader obtaining “sponsored access” to trade on an exchange through a

broker-dealer, subject to superivision by the broker-dealer providing sponsored access. In either

case, they are subject to stringent risk controls and disclosure requirements to prevent errone-

ously disruptive trading activity.90

Volatility controls are intended to minimize extreme price volatility in stocks that can be disruptive

to an orderly trading environment. Volatility controls include (i) market-wide trading halts or “cir-

cuit breakers” or (ii) circuit breakers for individual stocks that trigger when there is significant price

volatility during a specified period of time. Another type of volatility control is a “kill switch”

whereby a broker-dealer is required to adopt a mechanism to automatically halt their own trading

based on potentially erroneous trading activity.

In Mainland China, there is no regulatory requirement that exchanges adopt market-wide circuit

breakers and none presently exist.91 Exchanges in Mainland China have adopted individual stock

circuit breakers that trigger when a stock’s price fluctuates by 10% over a specified period of

time.92 In Hong Kong, there is also no regulatory requirement imposing a market-wide circuit

breaker and none presently exist. However, the HKEx has adopted individual stock circuit breakers

that trigger when a stock’s price fluctuates by 10% over a pre-specified period of time.93 The HKEx

86 HK Code of Conduct, 18.1-18.6. 87 See Section 3.e. 88 See Section 4.g. 89 See Section 5.f. 90 See Section 6.f. 91 In 2016, Shanghai/Shenzhen market-wide circuit breakers linked to the CSI 300 Index were removed. BLOOMBERG,

China Official Wants to Scrap First-Day Trading Cap for IPOs (Jan. 13, 2019) https://www.bloomberg.com/news/arti-

cles/2019-01-14/china-official-wants-to-scrap-first-day-trading-cap-for-ipos. 92 Trading Rules, Chapter III, 3.4.13-14 (Shanghai) / 3.3.15-16 (Shenzhen). 93 MARKETS MEDIA, HKEX to Roll Out Volatility Control Mechanism for its Securities Market (Aug. 19, 2016)

https://www.marketsmedia.com/hkex-roll-volatility-control-mechanism-securities-market/; HKEx, Trading Mechanism


also mandates that electronic traders adopt kill switches to immediately halt trading, but does not

specify when kill switches must be executed.94 In Japan, there is also no regulatory requirement

imposing a market-wide circuit breaker and none presently exist. The TSE imposes individual stock

circuit breakers that vary based on the absolute price of a stock.95 Neither the FSA nor the TSE

require that broker-dealers adopt kill switches.

In the European Union, there is no regulatory requirement for market-wide circuit breakers, and

neither the London Stock Exchange, Euronext, nor Deutsche Bourse have adopted any.96 Ex-

changes and multilateral trading venues are required to adopt circuit breakers for individual stocks

when there is significant price movement during a short period.97 A pre-defined statistically sup-

ported method must be used.98 Broker-dealers engaged in algorithmic trading are also required

to adopt kill switches allowing them to cancel all of their unexecuted orders with immediate effect,

when the broker-dealer determines that doing so is necessary.99

The United States, through a rule proposed by the US exchanges and approved by the SEC, is the

only jurisdiction we reviewed that imposes market-wide circuit breakers at price declines of 7%

(Level 1), 13% (Level 2) and 20% (Level 3) in the S&P 500.100 There can be only one 15-minute

trading halt per day for a Level 1 or Level 2 market decline. A Level 3 market decline halts trading

for the remainder of the trading day.101 The SEC also approved a rule proposed by the US ex-

changes and FINRA introducing individual stock circuit breakers that apply when a stock’s price

fluctuates from 5-20% depending on the price and liquidity of the stock.102 Neither the SEC nor

the exchanges impose mandatory kill switches on broker-dealers.

of Volatility Control (VCM) in the Securities Market (Aug. 12, 2016) https://www.hkex.com.hk/eng/market/sec_tradin-

fra/vcm_cas/Documents/Trading%20Mechanism%20for%20VCM%20Eng.pdf. 94 HK Code of Conduct, Schedule 7, 1.2.1. 95 INTERNATIONAL MONETARY FUND, MONETARY AND CAPITAL MARKETS DEPARTMENT (IMF), Japan: IOSCO Objectives and Principles

of Securities Regulation— Detailed Assessment of Implementation, IMF Country Report No. 12/230 (August 2012). 96 Jamres Brugler, Oliver Linton, Joseph Noss and Lucas Pedace, Staff Working Paper No. 759: The cross-sectional spillo-

vers of single stock circuit breakers, BANK OF ENGLAND, 8 (Oct. 2018), https://www.bankofengland.co.uk/-/me-

dia/boe/files/working-paper/2018/the-cross-sectional-spillovers-of-single-stock-circuit-breakers.pdf (listing LSE, Eu-

ronext and Deutsche Bourse as having only stock-specific circuit-breakers). 97 MiFID 2 Directive, Recital 64 and Article 48(5). 98 ESMA Guidelines ‘Calibration of circuit breakers and publication of trading halts under MiFID II’ (06/04/2017) 99 RTS 6, Recital 9 and Article 12. 100 Self-Regulatory Organizations; Notice of Filing of Amendments No. 1 and Order Granting Accelerated Approval of

Proposed Rule Changes as Modified by Amendments No. 1, Relating to Trading Halts Due to Extraordinary Market

Volatility, Exchange Act Release No. 67090 (May 31, 2012) http://www.sec.gov/rules/sro/bats/2012/34-67090.pdf. 101 See NYSE Rule 80B: Trading Halts Due to Extraordinary Market Volatility, available at

http://wallstreet.cch.com/nyse/rules/nyse-rules/chp_1_3/chp_1_3_4/chp_1_3_4_21/default.asp; Nasdaq Rule 4121:

Trading Halts Due to Extraordinary Market Volatility, available at http://nasdaq.cchwallstreet.com/NASDAQTools/TOC-

Chapter.asp?print=1&manual=/nasdaq/main/nasdaq-equityrules/chp_1_1/chp_1_1_4/chp_1_1_4_1/default.asp&se-

lectedNode=chp_1_1_4_1; 102 See Joint Industry Plan; Order Approving the Tenth Amendment to the National Market System Plan to Address

Extraordinary Market Volatility, Exchange Act Release No. 77679, File No. 4-631 2 (Apr. 21, 2016)

https://www.sec.gov/rules/sro/nms/2016/34- 77679.pdf.


Volatility Controls: Summary Chart

Jurisdiction

Existing Volatility Controls

Market-wide

Circuit-breakers

Stock-specific

Circuit-breakers

Broker-dealer

Kill Switches

European Union Not required, not

adopted by LSE, Eu-

ronext or Deutsche

Bourse

On all exchanges and other

venues, triggered by a signif-

icant price movement during

a short time period as deter-

mined by the venue’s prede-

termined methodology

Required by regulators of

algorithmic traders

Hong Kong Not required,

none exist

On HKEx, triggered by 10%

price fluctuations within a

specified time period

Required by HKEx of

electronic traders

Japan Not required,

none exist

On TSE, triggered by price

fluctuations in fixed yen val-

ues that increase in rough

proportion to the absolute

price of a stock

Not required

Mainland China Not required,

none exist

On SSE and SZSE, triggered

by 10% price fluctuations

within a specified period

Not required

United States Required, triggered

by pre-set one-day

price declines in the

S&P 500

On all exchanges, triggered

by one-day price fluctuations

that vary based on the price

and liquidity of the stock

Not required


The China Securities Regulatory Commission (“CSRC”) regulates stock exchanges according to

authorities established in the Securities Law (passed in 1998, and subsequently amended)103 and

regulations set forth in the CSRC’s Measures for the Administration of Stock Exchanges (last

amended in 2017):104

The establishment or dissolution of a stock exchange is a decision taken by the State Council (the

chief administrative authority of the People’s Republic of China). Article 102 of the Securities Law

and articles 6 and 9 of the Measures for the Administration of Stock Exchanges require applica-

tions for approval to be examined and verified by the CSRC before the State Council makes a

decision. 105

Stock exchanges and NEEQ106 must obtain the CSRC approval to to propose or amend their rules

and regulations on listing, trading, and member management.107 Further, the CSRC can require

stock exchanges and NEEQ to amend their constitutions or business rules as appropriate.108

CSRC is responsible for the supervision of exchanges and NEEQ to ensure market fairness and

integrity, as well as the transparent trading of securities and the protection of investors' inter-

ests.109 To that end, the general manager of a stock exchange is appointed by and dismissed by

the CSRC.110

103 Securities Law of the People's Republic of China (Mar. 16, 2007) http://english.mofcom.gov.cn/article/policyre-

lease/internationalpolicy/200703/20070304466356.shtml. 104 CHINA SECURITIES REGULATORY COMMISSION, Stock Exchange Management (Nov. 17, 2017).

http://www.csrc.gov.cn/pub/newsite/flb/flfg/bmgz/scjy/201805/t20180515_338140.html (link in Chinese);

https://www.leetsai.com/capital-markets/measures-for-the-administration-of-stock-exchanges-mainland-china (more

information available in English) 105 http://documents.worldbank.org/curated/en/363291512541399092/pdf/121861-WP-P157065-PUBLIC-ADD-FSAP-

SERIES-Financial-Sector-Assessment-Program-FSAP-China-FSAP-2017-DAR-IOSCO.pdf (p. 278) 106 The National Equities Exchange and Quotations Co., Ltd. (NEEQ, or The New Third Board) was launched in 2012 and

serves as a trading system for shares of public companies not listed on the Shanghai or Shenzhen stock exchanges. The

details of the regulation of the NEEQ are described later in this report. NEEQ is not an exchange established according

to the Securities Act. 107 Articles 103 and 118 of the Securities Law, Article 15 of the Measures, and Articles 15 to 19 of the Interim Measures

for the Administration of National Equities Exchange and Quotations Co., Ltd. (NEEQ Interim Measures) See http://doc-

uments.worldbank.org/curated/en/363291512541399092/pdf/121861-WP-P157065-PUBLIC-ADD-FSAP-SERIES-Finan-

cial-Sector-Assessment-Program-FSAP-China-FSAP-2017-DAR-IOSCO.pdf (p. 279) 108 See id. Section 89 of the Measures. 109 Article 10 of the Measures. See id. at 279-280. See also CSRC, Interim Measures for the Administration of National

SME Share Transfer System Co., Ltd., February 2, 2013. 110 Id. Article 107 of the Securities Law. The same is the case for the general manager of NEEQ. Id.


Stock exchanges and other trading systems

There are currently two stock exchanges for publicly-listed stocks in Mainland China, the Shanghai

Stock Exchange and the Shenzhen Stock Exchange, each formed as membership organizations

supervised by the CSRC.111 The two stock exchanges were established in 1990 and there have

been no applications to establish a new stock exchange since then.112

The Shanghai Stock Exchange has two boards, the main board and the STAR Board. On the main

board, 1,464 companies are listed, including 1,457 companies with A-Shares113 and 51 with B-

Shares114 with a total market capitalization of 33.7 trillion RMB (as of March 2019).115 Listing re-

quirements for the main board require at least 3-years of profitability and profit of more than 30

million RMB in the past years.116 The STAR Board was launched in July 2019 and lists 29 companies

(as of mid-2019).117 As explained in greater depth below, its listing standards allow non-profitable

and low-revenue companies to be listed under certain circumstances.

The Shenzhen Stock Exchange has three boards and over 2,000 companies are listed, with total

capitalization of 23.7 trillion RMB.118 The three boards are: 1) the main board (463 A-share com-

panies and 48 B-share companies); 2) SME Board (931 companies); and 3) ChiNext Board (749

companies).119 Listing requirements for the main board and the SME Board are the same as the

111 James Chen, Shanghai Stock Exchange (May 4, 2018) https://www.investopedia.com/terms/s/shanghai-stock-ex-

change.asp (“The Shanghai Stock Exchange (SSE) is… a nonprofit organization run by the China Securities Regulatory

Commission (CSRC).”); SHENZHEN STOCK EXCHANGE, About: Overview (last visited Apr. 12, 2019) http://www.szse.cn/Eng-

lish/about/overview/index.html (“Shenzhen Stock Exchange (SZSE), established on 1st December, 1990, is a self-regu-

lated legal entity under the supervision of China Securities Regulatory Commission (CSRC).”) 112 Commentary from Prof. Wang. 113 A-shares trading on the Shanghai and Shenzhen Exchange are RMB-denominated. Originally, A-shares were only

accessible to domestic investors. Now, A-shares are accessible to foreign investors via the QFII/RQFII programs

(launched in 2002 and 2011, respectively), Hong Kong-Shanghai Stock Connect (launched in 2014), and Hong Kong-

Shenzhen Stock Connect (launched in 2016). See http://english.sse.com.cn/investors/qfii/what/; http://eng-

lish.sse.com.cn/investors/qfii/what/; https://www.ftse.com/products/downloads/guide_to_chinese_share_classes.pdf.

Some A-shares are also now accessible to foreign investors via the Shanghai-London Stock Connect. See http://eng-

lish.sse.com.cn/products/equities/slsc/introduction/ 114 B-shares of Shanghai Exchange are USD-denominated, and were exclusively accessible to foreign investors at the

early stages of Chinese stock market in the 1990s. B-shares of the Shenzhen Stock Exchange are HKD-denominated,

and likewise were exclusively accessible to foreign investors in the 1990s. In 2001, B-shares became accessible to do-

mestic investors, and in 2002, new B-shares stopped being issued. See id.; http://blogs.reuters.com/george-

chen/2011/04/28/what-happened-to-b-shares/; https://www.webcitation.org/5xWv8uVXa?url=http://www.lehman-

law.com/resource-centre/faqs/securities/what-are-b-shares.html. 115 http://english.sse.com.cn/indices/publications/monthly/c/4758309.pdf (p. 4) 116 http://english.sse.com.cn/overseasinvestors/introduction/publications/sseinfrastructure/c/4405461.pdf (p. 11) 117 http://star.sse.com.cn/en/marketdata/overview/ 118 http://www.szse.cn/English/siteMarketData/marketStatistics/overview/index.html (accessed Apr. 7, 2019) 119 http://www.szse.cn/English/siteMarketData/marketStatistics/securities/index.html (accessed Apr. 7, 2019)

https://www.ftse.com/products/downloads/guide_to_chinese_share_classes.pdf

http://star.sse.com.cn/en/marketdata/overview/


listing requirements of Shanghai Stock Exchange. The ChiNext Board only requires 1-2 years of

profitability (and may be lowered further).120

The National Equities Exchange and Quotations Co., Ltd.121 (“NEEQ,” or The New Third Board) was

launched in 2012 and serves as a trading system for shares of public companies not listed on the

Shanghai or Shenzhen stock exchanges.122 As of December 2018, the NEEQ listed 10,691 compa-

nies, with a total market capitalization of 3.45 trillion RMB.123 NEEQ is directly regulated and su-

pervised by the CSRC.

NEEQ-traded stocks are only accessible to Qualified Investors (two years of experience in securi-

ties investing and 5 million RMB worth of securities in assets124). Companies primarily trade on

the NEEQ if they have been delisted from one of the main exchanges (for violating one of the

listing requirements) or if they do not satisfy them in the first place (for example, early stage

companies). NEEQ is highly significant because it is a primary channel through which not-yet-

profitable high-growth firms companies raise capital.125 However, all NEEQ companies that wish

to go public must first go through the same CSRC-administered registration process to be listed

on the Shenzhen or Shanghai stock exchange.

In 2016,126 the NEEQ introduced a two-tiered classification framework for the NEEQ that splits

companies listed on NEEQ into two categories of companies: (1) basic level; and (2) innovation

120 http://www.szse.cn/English/rules/siteRule/P020181124401754468452.pdf; http://www.china-

daily.com.cn/a/201812/19/WS5c199e13a3107d4c3a0018c5.html. 121 NEEQ is not an exchange established according to the Securities Act and does not trade securities listed on SSE or

SZSE. Because we are focusing on publicly-listed securities, we will only focus the two exchanges in China (SSE and

SZSE). NEEQ’s shareholders are: 1) Shanghai Stock Exchange; 2) Shenzhen Stock Exchange; 3) China Securities Deposi-

tory and Clearing Corporation, 4) China Financial Futures Exchange; 5) Shanghai Futures Exchange; 6) Zhengzhou Com-

modity Exchange; and 7) Dalian Commodity Exchange. 122 NATIONAL EQUITIES EXCHANGE & QUOTATIONS, Introduction (last accessed Sept. 26, 2019),

http://www.neeq.com.cn/en/services/investors_home/brief_intro.html (“Companies thereon are non-listed public com-

panies whose shareholders may be more than 200 people and shares can be transferred openly.”); WORLD BANK, People’s

Republic of China, Financial Sector Assessment Program: Detailed Assessment of Observance 12 (Oct. 2017), http://doc-

uments.worldbank.org/curated/en/860161518601604502/pdf/DAR-Securities.pdf. 123 http://www.neeq.com.cn/uploads/1/file/public/201901/20190102174019_iqq4hro9ua.docx 124 NATIONAL EQUITIES EXCHANGE & QUOTATIONS, Rules for Investor Suitability Management on the National Equities Exchange

and Quotations (July 1, 2017), http://www.neeq.com.cn/uploads/3/file/public/201906/20190611152558_0eifqr72i8.pdf.

See also BLOOMBERG, China's Third Stock Exchange Readies for Shanghai-Style Trading (Jan. 9, 2018), https://www.bloom-

berg.com/news/articles/2018-01-09/china-s-third-stock-exchange-readies-for-shanghai-style-trading 125 Ren-En Lim, Reviewing recent developments in China’s capital markets and assessing the relevance of the Proposed

Shanghai International Board, 12(1) CAPITAL MARKETS LAW JOURNAL 78 (Jan. 6, 2017), https://academic.oup.com/cmlj/arti-

cle/12/1/78/2856486. 126 SOUTH CHINA MORNING POST, China’s ‘third board’ emerges as threat to Hong Kong’s IPO market (June 1, 2016),

https://www.scmp.com/business/companies/article/1961549/chinas-third-board-emerges-threat-hong-kongs-ipo-

market





level, resulting in two tiers of NEEQ listing requirements.127 As of September 26, 2019, there were

8,556 “basic” level companies and 686 “innovation level” companies.128

NEEQ listing requirements for basic level companies include: (1) “be lawfully established”; (2) have

a “well-defined business plan,” “good corporate governance,” “a legitimate business”, and “clear

equity structure”; (3) conduct issuance and transfer of shares in accordance with the law; 4) “be

recommended and supervised by a legitimate brokerage”; and (5) “exist for two or more years.”129

There are not quantitative thresholds, such as minimum book value or profitability requirements.

To be listed as an innovation level company requires meeting all of the criteria above, and also

meeting one of three additional requirements related to profitability, liquidity, or the ability of the

company to grow.130

There are also approximately 40 regional stock trading platforms that serve as OTC markets for

companies within the region of the platform. According to the World Bank:

“Companies trading on these platforms cannot engage in a public offering of securities;

they are only allowed to sell their securities to qualified investors through a private place-

ment. Thus, as per the definition of public offering, they cannot have more than 200 share-

holders. Secondary market trading also is restricted to qualified investors. As per recent

guidance issued by the [State Council] such investors must be institutional investors or

individuals with more than 500,000 RMB in financial assets. Trading mechanisms vary; but

pursuant to the [State Council] instruments no trading platform may establish a market-

making system or provide a continuous auction or electronic matching capability, and a

lapse of 5 days must take place between the moment that an investor buys a securities

and the moment in which he/she sells it.”131

The size of these regional exchanges can be quite large – for example, Shenzhen’s regionally-

administered exchange has a market cap of 416 billion RMB and has more companies listed

(13,589) than NEEQ (~10,500).132 According to researchers at Tsinghua University, “Ventures can

apply online and, if accepted, provide whatever company information they choose and can offer

shares at a price they set.”

127 http://www.neeq.com.cn/uploads/1/file/public/201712/20171222185359_732ofg48kx.docx 128 NATIONAL EQUITIES & QUOTATIONS, Regular Statistics (last accessed September 26, 2019),

http://www.neeq.com.cn/static/statisticdata.html. 129 Jake Liddle, The NEEQ: A Stock Market for SMEs in China, CHINA BRIEFING (June 8, 2017), https://www.china-brief-

ing.com/news/neeq-chinas-new-stock-market-smes/ 130 Administrative Measures for the Hierarchical Management of Companies Listed on the National Equities Exchange

and Quotations for Trial Implementation (cited in https://www.burenlegal.com/sites/default/files/usercontent/content-

files/NEEQ_Special_Buren_2017.pdf) Listing requirements of “innovation level” are elaborated in Article 6.

http://www.neeq.com.cn/uploads/1/file/public/201712/20171222185359_732ofg48kx.docx 131 WORLD BANK, People’s Republic of China, Financial Sector Assessment Program: Detailed Assessment of Observance 12-

13 (Oct. 2017), http://documents.worldbank.org/curated/en/363291512541399092/pdf/121861-WP-P157065-PUBLIC-

ADD-FSAP-SERIES-Financial-Sector-Assessment-Program-FSAP-China-FSAP-2017-DAR-IOSCO.pdf. 132 SHENZHEN QIANHAI EQUITY EXCHANGE, Home Page, https://www.qhee.com/ .


In November 2018, PRC President Xi Jinping announced Shanghai Stock Exchange plans to create

a technology-focused trading board with more lenient trading regulations.133 Subsequently, in

July 2019, the Shanghai Stock Exchange launched its technology-focused STAR Board with 25

listed companies.134 Notable regulatory characteristics of the STAR Board that differ from the SSE’s

main board include:

• A much less stringent IPO application process that resembles a disclosure-oriented, regis-

tration-based process, although the CSRC can still intervene to reject SSE-approved list-

ings. 135

• Allowing unprofitable companies to go public, as long as those companies exceed certain

market capitalization thresholds and also meet certain revenue levels, exceed R&D invest-

ment thresholds, focus on certain government-approved businesses/products, and/or

meet other SSE-set criteria.136

• No price limit for the trading of a stock during the first five trading days it is listed on the

STAR Board and a daily price up/down limit of 20% for the stock beginning on the sixth

trading day after its listing137 (compared with 44% on the first day and 10% on subsequent

days for SSE and SZSE listed companies138).

• Requiring that STAR Board market participants have at least: 1) a securities and funds ac-

count daily average balance of no less than RMB 500,000 (excluding funds and securities

acquired via margin financing or securities lending) for 20 trading days prior to applying

to trade STAR Board-listed securities; and 2) already participated in securities trading for

133 http://star.sse.com.cn/star/en/infodisclosure/newsrelease/c/c_20190711_4860930.shtml 134 SHANGHAI STOCK EXCHANGE, The First Batch of 25 Companies Debuts on the SSE STAR Market (July 22, 2019), http://eng-

lish.sse.com.cn/aboutsse/news/newsrelease/c/4867619.shtml; Shen Hong, Stocks Surge on First Day for China’s Latest

Answer to Nasdaq, THE WALL STREET JOURNAL (July 22, 2019), https://www.wsj.com/articles/stocks-surge-on-chinas-new-

nasdaq-like-market-11563772327. 135 SHANGHAI STOCK EXCHANGE, Rules Governing the Listing of Stocks on the Science and Technology Innovation Board of

Shanghai Stock Exchange (2019) (English version), 1.3 & 2.1.1, http://star.sse.com.cn/star/en/regulation/c/4863743.docx.

See also SHANGHAI STOCK EXCHANGE, SSE STAR Board stock listing rules (revised April 2019) (上海证券交易所科创板股票上

市规则 (2019 年 4 月修订 )), 1.3 & 2.1.1 http://star.sse.com.cn/star/lawandrules/lawandrules/list-

ing/a/20190718/624fc40327d2dce4a7bd26de94ae9221.doc (link in Chinese). The CSRC has already began to use this

authority. See Shen Hong, Regulator Wields First IPO Veto on China’s New Tech Board, WALL STREET JOURNAL (Sept. 2,

2019), https://www.wsj.com/articles/regulator-wields-first-ipo-veto-on-chinas-new-tech-board-11567418856 136 SHANGHAI STOCK EXCHANGE, Rules Governing the Listing of Stocks on the Science and Technology Innovation Board of

Shanghai Stock Exchange (2019) (English version), 2.1.2, http://star.sse.com.cn/star/en/regulation/c/4863743.docx. See

also SHANGHAI STOCK EXCHANGE, SSE STAR Board stock listing rules (revised April 2019) (上海证券交易所科创板股票上市规

则 (2019 年 4 月修订 )), 2.1.2 http://star.sse.com.cn/star/lawandrules/lawandrules/list-

ing/a/20190718/624fc40327d2dce4a7bd26de94ae9221.doc (link in Chinese). 137 SHANGHAI STOCK EXCHANGE, Special Rules Governing the Trading of Stocks on the Science and Technology Innovation

Board of Shanghai Stock Exchange (2019), Article 18, http://english.sse.com.cn/laws/framework/c/4866516.docx. SHANG-

HAI STOCK EXCHANGE, Announcement of Essential SSE STAR Board Stock Trading Risk Provisions (上海证券交易所科创板

股票交易风险揭示书必备条款 ), p. 3, http://www.sse.com.cn/lawandrules/sserules/tib/trad-

ing/a/20190301/3519dc0272698f757db2d464c0622c0c.pdf (link in Chinese). 138 See infra notes 191-192 and accompanying text.

http://star.sse.com.cn/star/en/infodisclosure/newsrelease/c/c_20190711_4860930.shtml

http://star.sse.com.cn/star/en/regulation/c/4863743.docx

https://www.wsj.com/articles/regulator-wields-first-ipo-veto-on-chinas-new-tech-board-11567418856


http://www.sse.com.cn/lawandrules/sserules/tib/trading/a/20190301/3519dc0272698f757db2d464c0622c0c.pdf

http://www.sse.com.cn/lawandrules/sserules/tib/trading/a/20190301/3519dc0272698f757db2d464c0622c0c.pdf


over 24 months.139 According to one report, there are approximately 3 million current A-

share individual account holders who meet the 500,000 RMB threshold.140

Exchange trading systems

Securities trading on the exchanges is conducted via call auction or continuous auction, two dif-

ferent types of order-driven markets. Call auction refers to the process of one-time centralized

matching of buy and sell orders accepted during a specified period, while continuous auction

refers to the process of continuous matching of buy and sell orders on a one-by-one basis.141

Relevant rules and structures of the call auction and continuous auction processes are set forth

below:142

The trading systems of the two exchanges accept orders from their members between 9:15- 9:25

(opening call auction), 9:30- 11:30 and 13:00- 15:00 on each trading day.143

• After a 9:15 to 9:25 opening call auction, the continuous auction begins, which runs from

9:30 to 11:30 and from 13:00 to 15:00, except for the securities whose trading is suspended

and resumed during trading hours. The buy or sell orders which are not executed during

the call auction are automatically entered into the continuous auction.

• From 14:57 to 15:00, a call auction is executed for the market closing.144

During the continuous auction, orders are matched and executed based on the principles of price

priority and time priority.145 The principle of price priority means: “a priority is given to a higher

[priced] buy order over a lower [priced] buy order and a priority is given to a lower [priced] sell

order over a higher [priced] sell order.” The principle of time priority means: “for orders with the

same bid price or offer price, a priority is given to the order placed earlier.”

The Exchanges and NEEQ have established block trading systems to facilitate large volume trans-

actions.146 Transactions above certain thresholds can be negotiated through an Exchange-admin-

istered negotiation system.

139 SHANGHAI STOCK EXCHANGE, Rules Governing the Trading of Stocks on the Science and Technology Innovation Board of

Shanghai Stock Exchange, Article 4, (last accessed Sept. 26, 2019), http://star.sse.com.cn/star/en/regula-

tion/c/4866547.docx; SHANGHAI STOCK EXCHANGE, SSE STAR Board Special Regulations (上海证券交易所科创板股票交易

特别规定), 1-2, http://www.sse.com.cn/tib/marketrules/trading/a/20190302/3f9a97e01b70e73ac2325d506f4cc8a6.pdf

(link in Chinese). 140 Zhang Yu and Leng Cheng, China Speeds Final Rules For Start Of New High-Tech Board, CAIXIN (Mar. 2, 2019)

https://www.caixinglobal.com/2019-03-02/china-speeds-final-rules-for-start-of-new-high-tech-board-

101386432.html. 141 Definitions from Shanghai Trading Rules, Chapter III, Section 5. 142 This text and sub-bullets below are largely provided by research staff and Professor Wang Xian, with citations added

by R. Greene as possible. 143 Trading Rules, Chapter II, 2.4 & Chapter III, 3.3 (Shenzhen) / Chapter III, 3.4 (Shanghai). 144 SHANGHAI STOCK EXCHANGE, Adjusted Market-closing Trading Mechanism to Come into Effect on Aug. 20 (Aug. 6, 2018),

http://2016en.sse.com.cn/aboutsse/news/newsrelease/c/4610156.shtml. 145 Trading Rules, Chapter III, 3.6 (Shanghai) / 3.5 (Shenzhen): 146 Trading Rules, Section III, 3.7 (Shanghai) & 3.6 (Shenzhen); NEEQ Trading Rules, Articles 30, 73, 77, and 79,

http://www.neeq.com.cn/m/notice/200003539.html



http://www.sse.com.cn/tib/marketrules/trading/a/20190302/3f9a97e01b70e73ac2325d506f4cc8a6.pdf


Compared with the Exchanges’ order-driven systems, the trading volume of the block trading

system is very low. Across the Shenzhen and Shanghai stock markets, between February 2018 and

February 2019, block trades represented less than 0.1% of the RMB volume of all trades.147 Block

trades are not included in the Exchange’s real-time quotations and index calculation. Upon the

completion of block trades on each trading day, their trading volumes are added to the total

turnover of relevant securities.148 After the completion of block trades on each trading day, the

Exchange will, in case of block trades of stocks or mutual funds, release the securities names,

execution prices, trading volumes, and the names of brokerage branches involved.149

In 2012, Shanghai lowered the minimum quantity requirements for A-share block trades to

100,000 shares or 600,000 RMB from 500,000 shares or 3,000,000 RMB.150 For Shenzhen, the min-

imum A-share block trade quantity is 300,000 shares and 2,000,000 RMB.151 In May 2017, the CSRC

introduced rules increasing restrictions on block trading.152 According to the May 2017 rule

change, “substantial shareholders are barred from selling their holdings through so-called block

trades, in a manner that may ‘maliciously’ cause prices to plunge and hurt public confidence.”153

Self-regulatory authority

The securities exchanges are self-regulatory organizations, which exercise real-time monitoring of

unusual trading activities that may affect the trading price or trading volume of securities. The

“Trading Rules”154 established by the Shanghai and Shenzhen stock exchanges (the “Exchanges”)

related to these responsibilities include:155

• When an Exchange member or its branches discovers any investor involved in unusual

trading activities -- as defined in the Exchanges’ Trading Rules – and believes such activity

may seriously affect the order of the securities market, it shall “issue an alert and report to

the Exchange in a timely manner.”156

147 Data provided via market source. 148 Trading Rules, Chapter III, 3.7.6-7 (Shanghai) & 3.6.11-12 (Shenzhen). 149 Id. 150 Reuters, SHANGHAI EXCHANGE EASES BLOCK TRADE RESTRICTIONS (Mar. 13, 2012) https://www.reuters.com/article/china-

blocktrade-idUSL4E8EE0A920120314. 151 http://www.szse.cn/lawrules/index/rule/P020180605380740355263.pdf (link in Chinese). 152 http://www.sse.com.cn/lawandrules/regulations/csrcannoun/c/4033057.pdf (link in Chinese). 153 https://www.scmp.com/business/companies/article/2096004/chinese-regulator-tightens-rules-pace-substantial-

shareholders (citing http://www.csrc.gov.cn/pub/newsite/zjhxwfb/xwdd/201705/t20170527_317540.html (link in Chi-

nese)); See also http://english.gov.cn/policies/latest_releases/2017/05/28/content_281475669274608.htm 154 SHENZHEN STOCK EXCHANGE, Trading Rules (2016) http://www.szse.cn/English/rules/siteR-

ule/P020181124401737559498.pdf; SHANGHAI STOCK EXCHANGE, Trading Rules, http://english.sse.com.cn/tradmember-

ship/rules/c/3977570.pdf.

Note that throughout this document, while these English versions of the Shanghai and Shenzhen stock exchange Trad-

ing Rules are cited, the English versions of these rules may not technically reflect the most up-to-date rules (some

moderate/minor changes may have not been incorporated). That said, in instances where these English versions of the

relevant Trading Rules are cited, the text was generally agreed upon or provided by Prof. Wang Xian or colleagues. 155 The sub-bullets below regarding the Trading Rules are provided by Professor Wang Xian, with citations added by R.

Greene as possible. 156 Trading Rules, Chapter VI, 6.5 (Shenzhen) / 6.2 (Shanghai):

http://www.sse.com.cn/lawandrules/regulations/csrcannoun/c/4033057.pdf


• In the event of unusual trading activities that have a serious effect on the price or trading

volume of securities, the Exchange may conduct on-site inspections or off-site inspections

and require relevant members and their involved branches to provide relevant information

on involved investors.157

o Exchange members and investors shall coordinate with the Exchange in its inspec-

tions and provide relevant documents and information timely, truthfully, accurately,

and completely.158

o In severe cases of unusual trading activities, the Exchange may take the following

measures according to specific circumstances: (1) “oral or written warning”; (2)

summoning the parties involved for a meeting; (3) “requiring relevant investors to

provide a written commitment”; and (4) “restricting trading under relevant securi-

ties accounts”; and (5) reporting the matter to the CSRC.159 Shanghai Trading Rules

specifically mention the following two CSRC-related measures: (1) “applying with

the CSRC for freezing relevant securities accounts or cash accounts”; and (2) “filing

with the CSRC for investigation and punishment.”

• If an Exchange member violates any of the Trading Rules, the Exchange will order the

member to make rectification and may, depending on seriousness of the circumstances,

impose one or several of the following penalties: (1) “circulating a notice of criticism

among members”; (2) “publishing a public censure in CSRC-designated media”; (3) “sus-

pending or restricting trading”; (4) “revoking trading qualification”; or/and (5) “canceling

membership.”160

Alternative trading venues

According to the Securities Law, the trading of the shares of companies listed on an Exchange

must take place within that Exchange. As a result, “securities traded on [Mainland] China’s stock

exchanges are not cross-listed and trade on one exchange only.”161

Article 39 of the Securities Law provides that “Shares, corporate bonds and other securities pub-

licly issued pursuant to law shall be listed for trading on lawfully established stock exchanges, or

transferred at other securities trading sites approved by the State Council.” 162 No other trading

sites have been approved by the State Council. 163

157 Trading Rules, Chapter VI, 6.6-7 (Shenzhen) / 6.3 (Shanghai) 158 Trading Rules, Chapter VI, 6.7 (Shenzhen) / 6.4 (Shanghai) 159 Trading Rules, Chapter VI, 6.8 (Shenzhen) / 6.5 (Shanghai) 160 Trading Rules X, 10.1 Shanghai, Shenzhen Member Management Rules 12.1 161 THE WORLD BANK, People’s Republic of China: Financial Assessment Program: Detailed Assessment of Observance, 279

(Oct. 2017), http://documents.worldbank.org/curated/en/363291512541399092/pdf/121861-WP-P157065-PUBLIC-

ADD-FSAP-SERIES-Financial-Sector-Assessment-Program-FSAP-China-FSAP-2017-DAR-IOSCO.pdf. 162 Article 11 of the Stock Connect Rules has a parallel provision which prohibits securities trading service companies,

securities companies and brokers from independently matching orders or providing transfer services outside stock

exchanges for stocks traded via the stock connect. 163 SECURITIES LAW OF THE PEOPLE'S REPUBLIC OF CHINA, 11 (Jan. 1, 2006), https://www.accaglobal.com/con-

tent/dam/acca/global/pdf/ChinaSecuritiesLaw2006.pdf.


As a result, there are no alternative trading venues. As reported in February 2019 IOSCO research,

Mainland China does not allow dark pools164 and as further confirmed by MIT and NYU econo-

mists: “there are no dark pools with hidden orders in [Mainland] China, all orders are visible.”165

Trading fees

The CSRC and the National Development and Reform Commission jointly determine member

trading fees at stock exchanges; Mainland China is unique in giving regulators express authority

to set the trading fees to be charged by trading venues.166 Brokers compete freely with each other

to attract potential clients by offering competitive trading fees.

The CSRC has stated (in connection with a cut to trading fees) that fee schedules are determined

in part by reference to market size and environment, with the aim of utilizing them for the devel-

opment of markets and market infrastructure.167

Market data

The Exchanges “will disseminate real-time quotations, indices, public information and other trad-

ing information in respect of securities trading on each trading day.”168

The Exchanges each disseminate this data through wholly-owned subsidiaries, which offer three

tiers of data access: (1) Level-1 real-time market data released through the subsidiary’s broadband

broadcasting satellite system or the subsidiary’s internet service; (2) Delayed Level-1 market data

transferred via the subsidiary’s internet service; and (3) Real-time Level-2 market data transferred

via the subsidiary’s private network.169

Level-1 data includes real-time information on the top five buy and sell offers for each stock.170

Level-2 data includes the best 10 buy and sell orders for each stock. Exchange members receive

free access to Level-1 data. Non-members can purchase Level-1 data real-time or delayed from

the Exchange at market prices set by the Exchange.

164 IOSCO, IOSCO Standards Implementation Monitoring (ISIM) on Secondary and Other Market Principles, 19 (Feb. 2019),

https://www.iosco.org/library/pubdocs/pdf/IOSCOPD623.pdf. 165 http://english.ckgsb.edu.cn/sites/default/files/files/Carpenter%20Lu%20Whitelaw%202015%20-

%20The%20Real%20Value%20of%20China%27s%20Stock%20Market.pdf (p. 5) 166 http://www.csrc.gov.cn/pub/csrc_en/affairs/AffairsIOSCO/201402/P020140213529122654245.pdf. 167 http://www.csrc.gov.cn/pub/csrc_en/newsfacts/release/201205/t20120508_209698.html. 168 Trading Rule, Chapter V, 5.1.1: 169 http://english.sse.com.cn/indices/statistics/vendors/; http://www.szse.cn/English/services/dataServices/index.html

Data Price list on SSE:

Level-1 https://ic.sseinfo.com/doc/price/level-1-price.pdf

Level-2 https://ic.sseinfo.com/doc/price/level-2-price.pdf

Data Price list on SZSE:

Level-1 http://www.cninfo.com.cn/fwsq/hq/sfbz.htm

Level-2 http://www.cninfo.com.cn/fwsq/hq/sfbz-2.htm 170 See Trading Rules, Chapter V, 5.2 for other data fields available in real-time.


In 2006, the Shanghai Stock Exchange began to provide Level-2 market data through its subsidi-

ary,171 and now charges members or third parties seeking to purchase this data an annual market

price. The Shenzhen Stock Exchange also charges for Level-2 data fee service. The CSRC does not

regulate the price of Level-2 market data.

The brokerage businesses of securities firms are (i) regulated by the CSRC and (ii) subject to the

Exchange’s Trading Rules. In accordance with applicable CSRC rules172 and Exchange Trading

Rules, securities companies must treat their clients fairly.173 Other notable rules and restrictions

include:

• The brokers may not conduct internalized trades. Every order a broker receives must be

routed to the relevant exchange according to the instruction of the clients.174

• During the continuous auction, the Exchanges must disclose to Exchange members in real-

time the five lowest offer prices and five highest bid prices (and respective quantities) for

listed securities175 – this disclosure requirement is for transparency and also for the clients

to supervise the operation of their broker.176

• If the client suspects that their order is not receiving the best available price, then they can

lodge a complaint with the Exchange or the CSRC. If, after the investigation, it is deter-

mined that a broker did not route a client’s order to the Exchange in a timely manner, then

the Exchange will deal with the infraction in the event only its rules were broken, or if CSRC

rules are broken, then the CSRC will deal with the infraction.177

A securities firm cannot match the orders of its clients, and it must submit the orders of clients to

an exchange in a timely manner and in the same order that a member received them from a

client.178 Order-routing proceeds as follows:

• Upon the acceptance of an investor’s instruction, the broker shall place an order with the

Exchange as instructed and “assume corresponding trading and settlement obligations.”179

171 http://english.sse.com.cn/aboutsse/sseoverview/historical/c/c_20151201_4017781.shtml 172 http://www.csrc.gov.cn/pub/zjhpublic/zjh/200804/t20080418_14475.htm (link in Chinese) 173 This text and sub-bullets below are largely provided by Professor Wang Xian, with citations added by R. Greene as

possible. 174 China Securities Law Article 39 and Article 145. See also Article 111-112. See English version here: https://www.ac-

caglobal.com/content/dam/acca/global/pdf/ChinaSecuritiesLaw2006.pdf (p. 28)

http://www.csrc.gov.cn/pub/newsite/flb/flfg/flxzsf/201312/t20131205_239325.html 175 Exchange Trading Rules Chapter V, 5.2. 176 Commentary from Prof. Wang (see FN 40). 177 CHINA SECURITIES REGULATORY COMMISSION, Regulations on Strengthening the Management of Securities Brokerage Busi-

ness (2010) http://www.csrc.gov.cn/pub/zjhpublic/G00306201/201004/t20100416_179385.htm?keywords.

See also SHANGHAI STOCK EXCHANGE, Trading Rules, III, 3.6.5; SHENZHEN STOCK EXCHANGE, Trading Rules 3.5.4. 178 Trading Rules, Chapter III, 3.1.1-2 179 Trading Rules, Chapter III, 3.1.1.


• The broker shall route orders on a timely basis to the Exchange trading system. Client

orders needs to be time stamped when entering the order routing system of the securities

firm, and a timestamp is also required when the order arrives at the exchange.180

• After an order is matched by the trading system of the exchange, the Exchange must send

a trade record to the member in real time.181

• Exchange participants “shall keep under safe custody the records of their clients’ orders

and their order routing activities.”182

On the Shanghai and Shenzhen Stock Exchanges, the tick size for quotes and orders is RMB 0.01

for A-shares, RMB 0.001 for mutual funds shares, USD 0.001 for Shanghai-listed B shares, and HKD

0.01 for Shenzhen-listed B-shares.183

Mainland China does not directly regulate either algorithmic trading or HFT. In the past ten years,

mutual funds, securities companies and other professional investors have introduced algorithmic

trading to generate and execute orders automatically. However, HFT is effectively absent from the

stock market.184

There are several structural barriers to HFT in Mainland China. The cost of trading in Mainland

China is relatively high, which constrains HFT strategies that rely on executing a large volume of

trades: trades on the Shanghai and Shenzhen Stock Exchanges incur stamp duties of 10 bps (paid

by the seller) as well as other handling and regulatory fees (paid by both buyer and seller).185 In

addition, the latency offered by Mainland China’s exchanges are also not considered fast enough

for standard HFT strategies (price quotation refresh rates in Mainland China-listed securities typ-

ically range from 5 to 0.5 seconds).186

Moreover, according to trading rules on both the Shanghai and Shenzhen Stock Exchanges,

“[s]ecurities purchased by investors shall [generally] not be resold before settlement.”187 Accord-

ingly, a stock that is bought on day T and settled the night of T, cannot be sold until day T+1. (The

T+1 trading rule is the same for the NEEQ.188) The T+1 rule is prohibitive to most HFT strategies,

180 Trading Rules, Chapter III, 3.3.2 (Shenzhen) / 3.4.2 (Shanghai). 181 Trading Rules, Chapter III, 3.1.2 182 Trading Rules, Chapter III, 3.1.3 183 Trading Rules Chapter III, 3.3.13 (Shenzhen) / 3.4.11 (Shanghai). 184 See China’s Biggest Exchange Amps Up Trading Technology Systems, Bloomberg News (July 19, 2016), available at

https://www.bloomberg.com/news/articles/2016-07-19/china-s-biggest-exchange-amps-up-trading-technology-sys-

tems. 185 See SHANGHAI STOCK EXCHANGE, Fees and Taxes Charged or Collected by SSE (2019), available at http://eng-

lish.sse.com.cn/tradmembership/tradingfees/ (accessed Sep. 19, 2019); SHENZHEN STOCK EXCHANGE, Trading Fees (2019),

available at http://www.szse.cn/English/services/trading/tradingFees/index.html (accessed Sep. 19, 2019). 186 See Hao Zhou and Petko S. Kalev, Algorithmic and high frequency trading in Asia-Pacific, now and the future, 53

Pacific-Basin Finance Journal 186, 193 (2019). 187 Chapter III (Securities Trading), 3.1.4. 188 NEEQ Trading Rules, Article 36.

https://www.bloomberg.com/news/articles/2016-07-19/china-s-biggest-exchange-amps-up-trading-technology-systems

https://www.bloomberg.com/news/articles/2016-07-19/china-s-biggest-exchange-amps-up-trading-technology-systems

http://english.sse.com.cn/tradmembership/tradingfees/

http://english.sse.com.cn/tradmembership/tradingfees/

http://www.szse.cn/English/services/trading/tradingFees/index.html


which involve high turnover and holding limited overnight inventories. Notably, the T+1 rule was

not instituted to target HFT; it was implemented by the CSRC in the 1990s, well before the advent

of HFT.

The Exchanges impose a daily price limit on trading of stocks and mutual funds, with a daily price

up/down limit of 10% for individual stocks and mutual funds and a daily price up/down limit of

5% for individual stocks under special treatment (ST shares or *ST shares) (generally defined as

publicly listed firms that have reported negative profits for two years or more or that have a NAV

below par value189).190

The price limit does not apply to any of the following cases on the first trading day: (1) IPO shares

or closed-end funds; (2) secondary issuances; (3) shares whose listing is resumed after suspension;

or (4) other cases as recognized by the Exchange. With CSRC approval, Exchanges may adjust the

daily price up/down limit.

For IPOs and listing resumptions, a stock’s price may change by no more than +44% on its first

day of trading relative to its offering price.191 In January 2019, Fang Xinghai, vice chairman of the

CSRC was quoted saying that the CSRC “should review the first day trading cap for initial public

offerings,” and that “he personally [thinks] it should be removed.”192

In 2016, Shanghai/Shenzhen market-wide circuit breakers linked to the CSI 300 Index were re-

moved.193 The circuit breakers were intended to control dramatic fluctuations in the overall mar-

ket, but the consensus is that they had the opposite effect: the circuit breakers triggered more

panic-induced selling, as investors wanted to sell shares before the circuit breaker was trig-

gered.194

189 As explained by researchers examining the extent to which daily price limit rules may induce large investors to pursue

a destructive trading strategy of pushing prices and then selling the next day, “While the ST status is announced by the

exchange only after a firm formally releases its annual financial report, the market can well anticipate the ST assignment

immediately after the firm reports its eighth consecutive negative quarterly earnings or a low net asset value, which is

usually two or three months ahead of its annual report. During this interim period, the market anticipate that the firm

will be eventually labeled as ST but its stock is still trading under the regular 10% price limits.” https://www.prince-

ton.edu/~wxiong/papers/PriceLimit.pdf 190 Trading Rules, Chapter III, 3.4.13-14 (Shanghai) / 3.3.15-16 (Shenzhen) 191 ASIFMA, China’s Capital Markets: Navigating the Road Ahead, 23 (March 2017), https://www.asifma.org/wp-con-

tent/uploads/2018/07/china-capital-markets-final-english-version.pdf. See also SHANGHAI STOCK EXCHANGE, Shanghai

Stock Exchange adjusts the first day trading mechanism of new shares and related regulatory measures (June 16, 2014),

http://www.sse.com.cn/aboutus/mediacenter/hotandd/c/c_20150912_3988762.shtml. See also SHENZHEN STOCK EX-

CHANGE, 关于完善首次公开发行股票上市首日交易机制有关事项的通知 (June 13, 2014), http://www.szse.cn/law-

rules/rule/tradetype/stock/t20140613_565183.html. 192 BLOOMBERG, China Official Wants to Scrap First-Day Trading Cap for IPOs (Jan. 13, 2019), https://www.bloom-

berg.com/news/articles/2019-01-14/china-official-wants-to-scrap-first-day-trading-cap-for-ipos. 193 REUTERS, China suspends market circuit breaker mechanism after stock market rout (Jan. 7, 2016), https://www.reu-

ters.com/article/us-china-stocks/china-suspends-market-circuit-breaker-mechanism-after-stock-market-rout-

idUSKBN0UL1RC20160107. 194 See Winston W. Chang, Inner Workings of the Chinese Economy (May 1, 2019), https://papers.ssrn.com/sol3/pa-

pers.cfm?abstract_id=2752030.

http://www.sse.com.cn/aboutus/mediacenter/hotandd/c/c_20150912_3988762.shtml


The legal framework for securities trading in Hong Kong is set forth in the Securities and Futures

Ordinance (“SFO”).195 The SFO designates the Securities and Futures Commission (“SFC”) as the

main authority responsible for the regulation and supervision of securities markets, and charges

it with the development and the regulation of the securities and futures markets, as well as the

management of systemic risk in such markets. The SFC is a statutory body, with a board of direc-

tors appointed by the Chief Executive of Hong Kong (“CEHK”) or by the Financial Secretary (“FS”)

under delegated authority.196

Under the SFO, the SFC has direct responsibility for: (a) licensing of all market participants; (b)

monitoring market participants’ compliance with the SFO and subsidiary legislation, and SFC

codes, and acting on non-compliance; (c) monitoring the market and acting on suspected market

abuse and insider dealing; (d) monitoring issuers’ compliance with the obligation to disclose inside

information and certain substantial shareholding and short positions and acting on non-compli-

ance; (e) approving new exchange products through the rule approval process; and (f) monitoring

exchanges’ compliance with obligations under the SFO.197

Hong Kong Exchanges and Clearing Limited (“HKEx”) currently has a legal monopoly on operating

a stock exchange in Hong Kong, though the SFC can authorize the operation of other stock ex-

changes. The HKEx also exercises regulatory responsibilities in connection with primary and sec-

ondary equity markets. The HKEx approves offering documents for equity issuers that seek to

make a public offering, as well as for structured products (though the SFC has the power to object

to HKEx’s decision). The HKEx also conducts market surveillance for purposes of ensuring fair and

orderly trading, while the SFC monitors for market abuse and other unfair trading practices.198

HKEx and its exchanges are responsible for: (a) evaluating applications for admission as an ex-

change participant; (b) monitoring compliance by market participants with exchange rules and

acting on non-compliance; (c) admitting issuers to listing; (d) under delegated authority from the

SFC, approving prospectuses and offer documents for listed equity securities; (e) monitoring com-

pliance by issuers with listing rules and acting on noncompliance; (f) monitoring the market to

ensure that trading is orderly.199

195 See Laws of Hong Kong, Chap. 571. 196 See International Monetary Fund, Monetary and Capital Markets Department (IMF), People's Republic of China–

Hong Kong Special Administrative Region: IOSCO Objectives and Principles of Securities Regulation––Detailed Assess-

ment of Observance, IMF Country Report No. 14/205, 9 (July 2014). 197 See id at 70. 198 See id at 9. 199 See id at 70-71.


Key definitions

Algorithmic trading computer generated trading activities created by a predetermined set of

rules aimed at delivering specific execution outcomes.200

Alternative liquidity

pools or ALP

electronic systems operated by a licensed or registered person through

which the crossing/matching of orders involving listed or exchange traded

securities is conducted with no pre-trade transparency, including systems

designed and developed in-house or by a third-party service provider.201

Automated trading

services

services provided by means of electronic facilities, not being facilities pro-

vided by a recognized exchange company or a recognized clearing house,

whereby: (a) offers to sell or purchase securities or futures contracts or to

enter into OTC derivatives transactions are regularly made or accepted in

a way that forms or results in a binding transaction in accordance with

established methods, including any method commonly used by a stock

market or futures market; (b) persons are regularly introduced, or identi-

fied to other persons in order that they may negotiate or conclude, or with

the reasonable expectation that they will negotiate or conclude sales or

purchases of securities or futures contracts or OTC derivatives transactions

in a way that forms or results in a binding transaction in accordance with

established methods, including any method commonly used by a stock

market or futures market; (c) transactions (i) referred to in paragraph (a);

(ii) resulting from the activities referred to in paragraph (b); or (iii) effected

on, or subject to the rules of, a stock market or futures market, may be

novated, cleared, settled or guaranteed. Automated trading services do

not include such services provided by a corporation operated by or on

behalf of the government or any excluded services.202

Electronic trading trading of securities and futures contracts electronically and includes in-

ternet trading, direct market access and algorithmic trading.203

Exchange participant a person (a) who, in accordance with the rules of a recognized exchange

company, may trade through that exchange company or on a recognized

stock market or a recognized futures market operated by that exchange

company; and (b) whose name is entered in a list, roll or register kept by

that recognized exchange company as a person who may trade through

that exchange company or on a recognized stock market or a recognized

futures market operated by that exchange company.204

200 See SFC Code of Conduct, Section 18.2(a). 201 See SFC Code of Conduct, Section 19.2(b). 202 See SFO, Schedule 5, Part 2. 203 See SFC Code of Conduct, Section 18.2(d). 204 See SFO, Schedule 1, Part 1.


Licensed corporation

or LC

a corporation which is granted a license under the SFO to carry out regu-

lated activities, including dealing in or advising on securities.205

Recognized exchange

company

a company recognized under the SFO as an exchange company authorized

to operate a stock market or futures market.206

Recognized exchange

controller

a company recognized under the SFO as controller of a recognized ex-

change company.207

Under the SFO, the only recognized exchange controller in Hong Kong is HKEx, which operates

the only recognized exchange company, the Stock Exchange of Hong Kong Limited (“SEHK”).208

As of the end of March 2019, the SEHK had 2,346 listed companies with a total market capitaliza-

tion of more than HK$33.8 trillion.209

Off-exchange trading venues are permitted, but like exchanges they must be registered with and

regulated by the SFC.210 Hong Kong's statutory framework for off-exchange trading venues was

introduced in 2003.211 In December 2015, after a series of enforcement actions related to auto-

mated trading services provided by large financial firms, the SFC issued new regulations governing

the operation of alternative liquidity pools. In an April 2018 report on off-exchange trading, the

SFC noted that turnover on automated trading services fluctuated between 1% and 1.7% of total

securities market turnover between October 2016 and September 2017.212 Thus, the vast majority

of trading in Hong Kong takes place on the SEHK.

205 See SFO, Schedule 1, Part 1; Schedule 5, Part 1. 206 See SFO, Schedule 1, Part 1. 207 See SFO, Schedule 1, Part 1. 208 SECURITIES AND FUTURES ORDINANCE, A1241, https://www.sfc.hk/web/EN/pdf/laws/sfo/1/Ordi-

nance/5%20of%202002.pdf (“[T]he Stock Exchange Company… shall… be deemed to have been recognized as an ex-

change company.”). 209 https://www.hkex.com.hk/Market-Data/Statistics/Consolidated-Reports/HKEX-Monthly-Market-High-

lights?sc_lang=en. 210 SECURITIES AND FUTURES COMMISSION, Do you need a licence or registration? (Feb. 11, 2019)

https://www.sfc.hk/web/EN/regulatory-functions/intermediaries/licensing/do-you-need-a-licence-or-registra-

tion.html#1. 211 https://www.hksfa.org/upload/menu_content_detail/original/369866376630.pdf (p. 5) (“In Hong Kong, the concept

of licensing those carrying on the business of providing ATS was first introduced when the SFO came into effect in

2003.”). 212 Securities and Futures Commission, Report on the Thematic Review of Alternative Liquidity Pools in Hong Kong, 4

(Apr. 9, 2018) https://www.sfc.hk/web/EN/files/IS/publications/ALP%20Report%20(EN).pdf. See also Gregor Stuart

Hunter, Hong Kong’s ‘Dark Pools’ Start to Dry Up After New Rules Rolled Out, THE WALL STREET JOURNAL (Mar. 4, 2016)

https://www.wsj.com/articles/hong-kong-dark-pool-trading-volume-sinks-after-new-rules-rolled-out-1457095088 (“In

February [2016], automated trading services—a catchall term that includes dark pools—generated turnover of just 15.9

billion Hong Kong dollars (US$2 billion), representing just 1.3% of total market volume on the exchange and a record

low in absolute terms”).


Stock exchanges

The HKEx is the only recognized exchange controller under the SFO, and it owns and operates the

SEHK, the only stock exchange in Hong Kong. The HKEx is a listed company on the SEHK, and the

Government of Hong Kong retains more than 5 percent of the shares.213 Under the SFO, the Fi-

nancial Secretary (“FS”) has the power to appoint up to eight directors of HKEx.214 The appoint-

ment of directors by the FS is considered necessary to ensure adequate reflection of public interest

and interest of the investing public in decision making by the HKEx. The board of the SEHK is

appointed by HKEx as its sole shareholder, but the approval of the SFC is required for the appoint-

ment of the chief executive of the SEHK.215

The HKEx and the SEHK perform self-regulatory functions in the Hong Kong financial markets.

Under the SFO, a recognized exchange controller must ensure an orderly, informed and fair market

in securities traded on the stock market.216 The SFO provides that a recognized exchange company

must also ensure an orderly, informed and fair market in securities that are traded on that stock

market or through the facilities of that company, weighing the interest of the public more heavily

where it conflicts with the private interest of the recognized exchange company.217

The SFO authorizes a recognized exchange company to make rules for the proper regulation and

efficient operation of the market which it operates.218 However, rules of recognized exchange

companies and rule amendments only have effect once approved in writing by the SFC.219 In ad-

dition, the SFC, after consulting the FS and the relevant exchange, can make statutory rules on a

variety of matters relating to market activity, for example regarding the admission of exchange

participants, that can preempt the rules of the exchange company.220 The SEHK has adopted trad-

ing rules that govern participation in its stock market.

Access to exchanges

An entity that wants to participate directly in trading equities listed on the SEHK must apply to

become an exchange participant. The eligibility requirements and ongoing obligations of ex-

change participants are set out in the regulations of the SEHK. One of the eligibility criteria estab-

lished by the SEHK is that exchange participants must be licensed corporations.221

Trading information is disseminated directly to participants by the SEHK.222 The SEHK rules pro-

vide that all participants may use the software provided by the exchanges, by vendors or devel-

213 See IMF, Hong Kong: IOSCO Objectives and Principles of Securities Regulation at 69. 214 See SFO, Section 77. 215 See SFO, Section 26. 216 See SFO, Section 63(1). 217 See SFO, Section 21(1). 218 See SFO, Section 23(1). 219 See SFO, Section 24. 220 See SFO, Section 36. 221 See IMF, Hong Kong: IOSCO Objectives and Principles of Securities Regulation at 71. 222 See id.


oped in-house. Participants are free to choose trading devices which suit their business require-

ments and nature to access the trading systems. For example, the SEHK started offering co-loca-

tion services in November 2012. All participants have equal opportunity to obtain co-location

services, and among those participants who have trading systems at the co-location center, sys-

tem access time and latency are equal.223

Trading fees

Fees imposed by recognized exchanges controllers (such as HKEx) and recognized exchanges

companies (such as SEHK) must be specified in rules approved by SFC. In making its decision

on fee rules, SFC must take into account the level of competition, if any, in Hong Kong for the

matter for which the fee is to be imposed and the fees, if any, imposed by another recognized

exchange controller or recognized exchange company or any similar entity outside Hong Kong

for equivalent matters.225 The SFC does not permit tailored or negotiated fees.226

Each purchase and sale of securities on the SEHK incurs (i) a stamp duty imposed (0.1% of the

value of the transaction, taxed to both the buyer and seller),227 (ii) an HKEx trading fee (0.005% of

the price paid, charged to both the buyer and seller), (iii) an HKEx transaction levy (0.0027% of the

price paid, charged to both buyer and seller), and (iv) an HKEx trading tariff (HK$0.50 payable per

transaction).228 According to June 2018 statements by HKEx CEO Charles Li, “HKEX is considering

whether to ask the government to reduce or remove [the 0.1%] stamp duty” on both sides of a

trade in an effort to increase trading volume.229 Notably, HKEx’s fee structure does not discrimi-

nate between makers and takers of liquidity.230

Alternative trading venues

Hong Kong's regulation of off-exchange trading venues was introduced in 2003.231 Pursuant to

the SFO, only LCs holding a Type 7 authorization (for providing automated trading services)232

223 See id at 204. 224 SFO, Section 76. 225 See SFO, Section 76. 226 See INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS, Trading Fee Models and their Impact on Trading Behaviour

15 (Dec. 2013) https://www.iosco.org/library/pubdocs/pdf/IOSCOPD430.pdf. 227 Hong Kong Stamp Duty Ordinance (Cap 117) (July 1, 1981), https://www.elegislation.gov.hk/hk/cap117. 228 HONG KONG STOCK EXCHANGE, Transaction: Securities (Hong Kong) (Sept. 26, 2016) https://www.hkex.com.hk/Ser-

vices/Rules-and-Forms-and-Fees/Fees/Securities-(Hong-Kong)/Trading/Transaction?sc_lang=en. 229 https://www.bloomberg.com/news/articles/2018-01-08/hong-kong-eyes-new-trading-rules-adding-rebates-to-

spur-volume; https://www.bloomberg.com/news/articles/2017-10-13/hong-kong-exchange-said-to-consider-asking-

for-trading-tax-cut. 230 Id. (drawing no distinction between liquidity makers and takers). See also DEUTSCHE BANK, Global Market Structure:

Guide to Global Equity Exchanges (Feb. 2019) https://www.autobahn.db.com/equity-market-guide/mktgd/ex-

changes.html; INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS, Trading Fee Models and their Impact on Trading

Behaviour 18 (Dec. 2013) https://www.iosco.org/library/pubdocs/pdf/IOSCOPD430.pdf (excluding HKEx from the list of

trading venues including standard or inverted maker-taker pricing as part of their fee model). 231 https://www.hksfa.org/upload/menu_content_detail/original/369866376630.pdf (p. 5) (“In Hong Kong, the concept

of licensing those carrying on the business of providing ATS was first introduced when the SFO came into effect in

2003.”). 232 See SFO, Schedule 5, https://www.elegislation.gov.hk/hk/cap571.


and the registered persons of such authorized LCs can provide automated trading services

(“ATS”).233 ATS operators that trade securities listed on the SEHK must be generally licensed to

carry on the business of dealing in securities and specifically licensed to carry on the business of

providing ATSs.234

There are no statutory obligations concerning pre- and post-trade transparency for ATS. In regard

to post-trade transparency, pursuant to the trading rules of the HKEx all trades conducted through

ATS must be reported to the HKEx within one minute after execution (other trades that are exe-

cuted off-exchange must be reported within 15 minutes). This allows the HKEx (and vendors) to

provide consolidated post-trade information.235

In December 2015, after a series of enforcement actions related to ATSs provided by large financial

firms, the SFC issued new regulations governing the operation of alternative liquidity pools

(“ALPs”). ALPs are electronic systems operated by broker-dealers through which the crossing or

matching of orders (including the internalization of orders) is conducted anonymously without

any pre-trade transparency (i.e., dark trading).236 The SFC has described ALPs as an electronic sub-

set of ATS.237 Since they provide ATS, ALP operators are required to report and flag to the HKEX

all transactions conducted on their ALPs within one minute after trade execution.238

Only institutional investors, including professional/experienced investors with a net worth of over

HK$40 million or an investment portfolio of at least HK$8 million, are allowed to use ALPs.239

Notably, as of 2016 retail investors account for approximately 25 percent of trading value on the

SEHK.240

There is no explicit statutory requirement for exchanges to provide pre-trade transparency as to

the best bid and ask quotations and market depth for stocks. However, the trading rules of the

SEHK prohibit dark trading, so pre-trade transparency exists in practice.241 In addition, foreign

233 SECURITIES AND FUTURES COMMISSION, Do you need a licence or registration? (Feb. 11, 2019)

https://www.sfc.hk/web/EN/regulatory-functions/intermediaries/licensing/do-you-need-a-licence-or-registra-

tion.html#1. 234 https://www.hksfa.org/upload/menu_content_detail/original/369866376630.pdf (p. 4) 235 See IMF, Hong Kong: IOSCO Objectives and Principles of Securities Regulation at 214. 236 Id. 237 Securities and Futures Commission, Consultation Paper Concerning the Regulation of Alternative Liquidity Pools, 4

(Feb. 27, 2014) https://www.sfc.hk/edistributionWeb/gateway/EN/consultation/doc?refNo=14CP3 (”ALPs are also

known by other names such as electronic ‘alternative trading systems’ and, in Hong Kong, the operation of an ALP

requires a broker-dealer operator to be licensed under the Securities and Futures Ordinance (SFO) to carry on the

business of providing “automated trading services” (ATS).”). 238 https://www.sfc.hk/edistributionWeb/gateway/EN/consultation/openFile?refNo=14CP3 239 http://hk-lawyer.org/content/enhancing-hong-kong%E2%80%99s-dark-pools-regime-will-benefit-industry-say-of-

ficials 240 https://www.hkex.com.hk/news/news-release/2017/170713news?sc_lang=en 241 International Monetary Fund. Monetary and Capital Markets Department, People’s Republic of China–Hong Kong


Regulation-Detailed Assessment of Observance, Country Report No. 14/205, 212 (July 16, 2014).


trading venues are prohibited by SEHK regulations from facilitating off-exchange dark trading of

SEHK-listed stocks in Hong Kong.242

Likewise, there is no statutory requirement for post-trade transparency, but it is mandated by the

trading rules of the SEHK. Post-trade information includes last traded price, day high, day low,

closing price and trading volume.243 Through HKEx-approved information vendors, investors can

access live feeds and 15-minute delayed feeds including trade times, prices and quantities.244 In

addition, HKex also provides end-of-day trade data by security, including turnover by volume in

HK dollars (HK$).245 Further, SEHK rules apply post-trade transparency obligations to trades exe-

cuted off exchange by exchange participants: off-exchange trades must be reported to the SEHK

within 15 minutes after the conclusion of the transactions.246

The best execution provision of the SFC’s Code of Conduct requires licensed corporations

(“LCs”)247 acting for or with clients to “execute client orders on the best available terms.”248 LCs are

the Hong Kong-equivalent of U.S. broker-dealers.

In January 2018, the SFC issued a circular to licensed corporations on best execution.249 The circu-

lar emphasizes that “sufficient steps should be taken to obtain the best available terms when

executing client orders, taking into account” factors such as (1) price, (2) cost, (3) speed of execu-

tion, (4) likelihood of execution, (5) speed of settlement, (6) likelihood of settlement, and (7) the

size and nature of an order, noting that “the relative importance of each best execution factor

may vary from case to case and best execution of certain types of instructions should be assessed

242 Email exchange with HKEx. 243 International Monetary Fund. Monetary and Capital Markets Department, People’s Republic of China–Hong Kong


Regulation-Detailed Assessment of Observance, Country Report No. 14/205, 212-213 (July 16, 2014),

https://www.imf.org/en/Publications/CR/Issues/2016/12/31/Peoples-Republic-of-ChinaHong-Kong-Special-Adminis-

trative-Region-Financial-Sector-Assessment-41750. 244 HONG KONG STOCK EXCHANGE, Information Vendors List (updated Aug. 31, 2019), https://www.hkex.com.hk/Ser-

vices/Market-Data-Services/Real-Time-Data-Services/Data-Licensing/Market-Data-Vendor-Licence/Information-Ven-

dors-List?sc_lang=en. HONG KONG STOCK EXCHANGE, Market Data Services: Historical Data (last accessed Oct. 2, 2019),

https://www.hkex.com.hk/eng/ods/historicalData.aspx#LC6oZm8xGDafsBcnRRE7Qg. 245 HONG KONG STOCK EXCHANGE, Market Data Securities Prices: Equities (last accessed Sept. 21, 2019),

https://www.hkex.com.hk/Market-Data/Securities-Prices/Equities?sc_lang=en&sort=0. 246 See IMF, Hong Kong: IOSCO Objectives and Principles of Securities Regulation at 212-13. 247 Those licensed by SFC under the Securities and Futures Ordinance. 248 SECURITIES AND FUTURES COMMISSION, Code of Conduct for Persons Licensed by or Registered with the Securities and Fu-

tures Commission (Nov. 25, 2018) https://www.sfc.hk/web/EN/assets/components/codes/files-cur-

rent/web/codes/code-of-conduct-for-persons-licensed-by-or-registered-with-the-securities-and-futures-commis-

sion/code-of-conduct-for-persons-licensed-by-or-registered-with-the-securities-and-futures-commission.pdf. 249 https://www.sfc.hk/edistributionWeb/gateway/EN/circular/doc?refNo=18EC7


against multiple factors.” 250 The circular also notes that “where a client has given specific instruc-

tions which cover one part or aspect of an order, this should not be treated as releasing LCs from

their best execution obligations for other parts or aspects of the order.”251

The January 2018 circular on best execution emphasizes that “delivering best execution is funda-

mental to market integrity and protection of investors who rely on LCs to act in their best interests

during the execution process.”252 Regarding the applicability of best execution, the January 2018

report explains that “when LCs enter into agency or back-to-back principal transactions with cli-

ents, the obligation to deliver best execution remains with LCs where clients rely on LCs to protect

their interests in order execution.”253 The report also states that orders should be executed in the

order that they are received.254

After a licensed corporation has effected a transaction on behalf of a client, it is required to

promptly confirm the essential features of the transaction with the client (unless otherwise agreed

to by the client in writing).255 Though the details of this requirement are not specified, the SFC has

identified as a good practice the preparation of post-trade execution reports that compare the

execution outcomes of client orders to benchmarks such as VWAP, to be provided to clients upon

request.256

The SFC allows third party payments related to the routing or execution of trade orders, but man-

dates that “firms that exercise investment discretion on behalf of clients” should “only receive

goods and services from a broker in relation to directing business to them if they benefit the

client, the execution is consistent with the best execution standards, the client has consented in

writing to the receipt of the goods and/ or services and disclosure on the firm’s practices for

receiving the goods and/ or services is made to the client.”257 In addition, firms are required “to

ensure that where conflicts of interest cannot be prevented, clients are nevertheless treated

fairly”258 and to “disclose any material interest in a transaction that is a conflict of interest to cli-

ents.”259

250 See id at 2. 251 See id 252 https://www.sfc.hk/edistributionWeb/gateway/EN/circular/openAppendix?refNo=18EC7&appendix=0 253 Id. 254 Id. 255 See SFC Code of Conduct, 8.2(a). 256 See SFC, Report on the Thematic Review of Best Execution (January 30, 2018), at 5. 257 Code of Conduct, 13.1 258 Code of Conduct, General Principle 1 259 Code of Conduct, 10.1


The table below highlights the minimum spread applicable for certain stocks that trade on the

SEHK.260 The SFC must approve changes to these tick sizes. ALPs adopt their own tick size rules,

often with reference to the tick sizes on exchanges.261

Price of securities Minimum spread

0.01 ≤ p < 0.25 0.001

0.25 < p ≤ 0.5 0.005

0.5 < p ≤ 10 0.01

10 < p ≤ 20 0.02

20 < p ≤ 100 0.05

100 < p ≤ 200 0.1

200 < p ≤ 500 0.2

500 < p ≤ 1000 0.5

1000 < p ≤ 2000 1

2000 < p ≤ 5000 2

5000 < p ≤ 9995 5

In January 2014, the SFC’s Code of Conduct was updated to include new rules governing electronic

trading. The new rules apply to firms already registered with or licensed by the SFC that engage

in electronic trading, including internet-based trading as well as algorithmic trading.

The Code of Conduct requires that all firms engaged in electronic trading or operating electronic

trading systems: (1) control and supervise orders; (2) manage and supervise the ”design, develop-

ment, deployment and operation of the electronic trading system”; and (3) ensure adequate se-

260 https://www.hkex.com.hk/Global/Exchange/FAQ/Securities-Market/Trading/Securities-Market-Opera-

tions?sc_lang=en 261 See, e.g., CREDIT SUISSE, Asia Pacific Crossfinder User Guidelines (2018) https://www.credit-suisse.com/me-

dia/ib/docs/investment-banking/client-offering/crossfinder-user-guidelines-2018.pdf (“Crossfinder internal Tick Size:

Half of HKEx tick size”); MORGAN STANLEY HONG KONG SECURITIES LIMITED, ALP Guidelines for MS POOL for the Hong Kong

Market (Mar. 2018) https://www.morganstanley.com/institutional-sales/hkdp-guidelines-mspool-mar2018.pdf (“MS

POOL accepts orders at full or half the SEHK standard tick sizes.”).

https://www.hkex.com.hk/Global/Exchange/FAQ/Securities-Market/Trading/Securities-Market-Operations?sc_lang=en

https://www.hkex.com.hk/Global/Exchange/FAQ/Securities-Market/Trading/Securities-Market-Operations?sc_lang=en


curity, reliability, and capacity, and keep detailed records of all aspects of the trading system in-

cluding audit logs.262 It also mandates that all electronic trading firms append risk disclosure state-

ments to their client contracts,263 which include both generic and (if appropriate) specific disclo-

sures as to the risks of electronic trading.264 This rule aims to facilitate, among other things, client

understanding of the risks of the technologies employed by electronic trading firms.265

The Code of Conduct also has rules that are specific to algorithmic trading. Algorithmic traders

must (1) “ensure that the algorithmic trading system and trading algorithms it uses or provides to

clients… are adequately tested to ensure that they operate as designed” and (2) adopt risk man-

agement controls to preserve the integrity of its algorithms and ensure they “operate in the inter-

est of the integrity of the market.”266 In addition, algorithmic trading systems must be tested at

least once per year with adequate recordkeeping maintained for at least two years, and risk man-

agement controls must be put in place.267

In December 2016, the SFC issued a circular to firms engaged in algorithmic trading assessing

overall compliance with the 2014 updates to the Code of Conduct.268 The circular highlighted five

areas of compliance deficiency and need for improvement, including: (1) insufficient involvement

from management and control functions regarding governance of algorithmic trading; (2) insuf-

ficient pre-trade controls; (3) inadequate due diligence of algorithmic trading systems provided

by third-party providers; (4) lack of written contingency plans to cope with potential emergencies

specific to algorithmic trading; and (5) absence of policies and procedures for testing algorithmic

trading systems.269

The Code of Conduct does not include rules that apply specifically to HFT, though the general

rules applicable to algorithmic trading would also apply to HFT. There are also structural barriers

to the use of HFT strategies in Hong Kong equity markets. Stamp duties on the transfer of listed

securities, as well as other transaction fees, precede the advent of HFT, but increase the cost of

executing HFT strategies.270 The “tick rule”, which provides that a short sale order for a security

262 Code of Conduct, 18.1-18.6. 263 Code of Conduct, Schedule 1 (“The substance contained in the following risk disclosure statements is

considered to be the minimum required. A licensed or registered person may elect to provide additional risk disclosure

information as appropriate… The substance contained in the following declaration by staff and acknowledgement by

client is considered to be the minimum required.”). 264 Code of Conduct, Schedule 1 (“If you undertake transactions on an electronic trading system, you will be exposed

to risks associated with the system including the failure of hardware and software. The result of any system failure may

be that your order is either not executed according to your instructions or is not executed at all.”). 265 Robert J. Kauffman, Yuzhou Hu and Dan Ma, Will high-frequency trading practices transform the financial markets

in the Asia Pacific Region?, 1 Financial Innovations 1, 16 (2015). 266 Code of Conduct, 8.10-8.11. 267 Code of Conduct, Schedule 7, 3.2-3.4. 268 SECURITIES AND FUTURES COMMISSION, Circular to all Licensed Corporations on Algorithmic Trading (Dec. 13, 2016)

https://www.sfc.hk/edistributionWeb/gateway/EN/circular/intermediaries/supervision/doc?refNo=16EC67. 269 SECURITIES AND FUTURES COMMISSION, Circular to all Licensed Corporations on Algorithmic Trading (Dec. 13, 2016)

https://www.sfc.hk/edistributionWeb/gateway/EN/circular/intermediaries/supervision/doc?refNo=16EC67. 270 See the discussion of “Trading fees” in Section 3.b above. Because some of the transaction fees are charged on a

per-trade basis on top of the standard volume basis, HFT strategies are disproportionably affected given their relatively

small trade sizes.


cannot be made on the SEHK if it is below the security’s prevailing ask price, is also an impediment

to certain HFT strategies.271 As such, HFT has historically represented a lower share of equity trad-

ing in Hong Kong than the United States and Japan (as of 2012, it represented 20 percent of equity

trading volume).272

In 2016, HKEx introduced a volatility control mechanism (“VCM”) for individual stocks to prevent

“extreme price volatility arising from major trading errors and other unusual incidents.”273 The

VCM is applicable to the index constituents of the Hang Seng Index (about fifty companies) and

the Hang Seng China Enterprise Index (about eighty securities).274 These indices account for ap-

proximately two-thirds of the total market capitalization of the SEHK. The HKEx does not have a

market-wide circuit breaker that halts trading of multiple stocks based on market-wide volatility.

The VCM is applicable to the HKEX’s entire continuous trading session, except for:275 the first 15

minutes of the morning and afternoon trading sessions; the first 15 minutes after a market re-

opening; and the last 20 minutes of the afternoon trading session.

The VCM operates as follows: If the trading price of a stock to which the VCM applies changes by

more than ±10% relative to the reference price (as defined by the price from 5 minutes earlier), a

5 minute cooling-off period will be triggered.276 During the cooling-off period, trading is restricted

and must be within the trading band range of 10 percent above and below the cooling-off period

reference price.277 Any order that exceeds this price band will be rejected by the exchange. In

addition, the system will also cancel the highest-priced buy order in the buying queue (that is,

where the buying price is higher than the price limit) or the lowest-priced sell order in the selling

queue (that is, where the selling price is lower than the lower price limit).278 The VCM can be

triggered at most once during SEHK’s morning trading session, and at most once during SEHK’s

afternoon trading session. Normal trading resumes for the VCM-triggered stock after the cooling-

off period. Once a cooling off period is triggered by the VCM, the market is notified of the acti-

vated price limits and time of VCM expiration.279

With respect to electronic trading, the SFC’s Code of Conduct requires licensed and registered

firms to ensure that their electronic trading systems enable them to: “(a) immediately prevent the

271 STOCK EXCHANGE OF HONG KONG, Rules of the Exchange, Schedule 11(15). 272 Robert Kauffman, Yuzhou Hu and Dan Ma, Will high-frequency trading practices transform the financial markets in

the Asia Pacific Region? (2015), https://link.springer.com/content/pdf/10.1186%2Fs40854-015-0003-8.pdf 273 https://www.marketsmedia.com/hkex-roll-volatility-control-mechanism-securities-market/ 274 https://www.marketsmedia.com/hkex-roll-volatility-control-mechanism-securities-market/ 275 https://www.hkex.com.hk/eng/market/sec_tradinfra/vcm_cas/Documents/VCM%20CAS%20Web%20Cor-

ner%20FAQ%20ENG.pdf (p. 13) 276 https://www.hkex.com.hk/eng/market/sec_tradinfra/vcm_cas/Documents/VCM%20CAS%20Web%20Cor-

ner%20FAQ%20ENG.pdf (p. 13) 277 https://www.ft.com/content/17f3fba8-6828-11e6-ae5b-a7cc5dd5a28c 278 HONG KONG EXCHANGE, Frequently Asked Questions (May 26, 2017), https://www.hkex.com.hk/eng/market/sec_tradin-

fra/vcm_cas/Documents/VCM%20CAS%20Web%20Corner%20FAQ%20ENG.pdf. 279 https://www.mayerbrown.com/-/media/files/perspectives-events/publications/2015/07/hong-kong-to-introduce-

volatility-control-mechanis/files/get-the-full-update/fileattachment/150723-hkgprc-corporatesecurities.pdf


system from generating and sending orders to the market; and (b) cancel any unexecuted orders

that are in the market.”280 This “kill-switch” functionality empowers firms to immediately halt their

trading in the event of uncertainty, error or high volatility. Further, all entities trading on the Hong

Kong Futures Automated Trading System (“HKATS,” operated by HKEx) are required to use the

HKATS Risk Functions software, which among other things empowers users to execute mass order

cancellation.281

280 Code of Conduct, Schedule 7, 1.2.1. 281 HONG KONG EXCHANGES AND CLEARING LIMITED, HKATS Risk Functions User’s Guide (June 2018) https://www.hkex.com.hk/-

/media/HKEX-Market/Services/Trading/Derivatives/Overview/Trading-Mechanism/Pre-Trade-Risk-Management-

(PTRM)-System-in-Derivatives-Markets/HKATS_Risk_Functions_User_Guide.pdf?la=en. See also HONG KONG EXCHANGES

AND CLEARING LIMITED, Information Paper: Pre-Trade Risk Management (PTRM) System in Derivatives Market (June 2015)

https://www.hkex.com.hk/-/media/HKEX-Market/Services/Trading/Derivatives/Trading-Mechanism/Pre-Trade-Risk-

Management-(PTRM)-System-in-Derivatives-Markets/Information-Paper/PTRM_Info_Paper.pdf.


MiFID 2, together with its predecessor MiFID 1, provides an overarching framework282 for securi-

ties trading in the EU, covering financial instruments, investments firms (as entities who deal

in/with financial instruments, similar to U.S. broker-dealers), and trading venues, including regu-

lated markets (as places where financial instruments are dealt with, similar to U.S. stock ex-

changes).

Although MiFID 2 provides a general framework, there are regulatory differences amongst the EU

Member States in relation to MiFID 2 implementation,283 because Member States284 have certain

discretion as to how to implement EU Directives and EC Delegated Directives within the limits

provided therein.285 Only EU Regulations apply automatically in the Member States from their

effective date.286

The original MiFID, the Markets in Financial Instruments Directive,287 was finalized in 2004 and has

been in force in the EU since November 2007. It strengthened a single market for investment

services288 and activities in the EU (sometimes referred to as ‘passporting’)289 and abolished the

concentration rule in which Member States of the EU could require investment firms to route

clients’ orders to domestic regulated markets, preventing competition between national ex-

changes and alternative trading venues.290

282 MiFID II is in that respect similar to the original MiFID, but is wider in reach when it comes to, for example, the

definition of ‘trading venue’, see Developments in Banking Law, Review of Banking & Financial Law, Vol. 37, footnote

39 on p. 609 (for more detail see World Bank Working Paper No. 184, ‘Comparing European and US Securities Regula-

tions (2010), p. 2). 283 For example, the UK and France have different views on research commissions, which may affect their implementa-

tion approaches, see https://www.fnlondon.com/articles/five-ways-uk-and-french-differ-on-mifid-research-rules-

20160930. 284 Specifically, Member States designate “National Competent Authorities” to implement directives within their area of

expertise. For example, the “National Competent Authority” for securities and markets in the United Kingdom is the

Financial Conduct Authority. EUROPEAN SECURITIES AND MARKETS AUTHORITY, Board of Supervisors and NCAs (last accessed

Aug. 14, 2019) https://www.esma.europa.eu/about-esma/governance/board-supervisors-and-ncas. 285 In the MiFID 2 case, that is the position with, for example, the research and execution payments unbundling provi-

sions. 286 In the MiFID 2 case, that is the position with, for example, the double volume cap mechanism for certain dark trading

in equities. 287 Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instru-

ments. 288 The single market for investment services was introduced in various steps. See, e.g., European Council Directive

85/611/EEC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective

investment in transferable securities (UCITS) (Dec. 20, 1985) (facilitating the cross-border offerings of investment funds

to retail investors); European Council Directive 93/22/EEC on investment services in the securities field (May 10, 1993)

(introducing “passporting” for investment services). 289 In the EU, trading is fragmented across many execution venues. One can trade shares in one EU country, in relation

to shares listed on an exchange in another EU country. So, for example, in London, one can trade on Turquoise, a

multilateral trading facility (defined below), in securities from 18 European countries. 290 World Bank Working Paper No. 184, ‘Comparing European and US Securities Regulations (2010), pp. 14 – 15.

https://www.fnlondon.com/articles/five-ways-uk-and-french-differ-on-mifid-research-rules-20160930

https://www.fnlondon.com/articles/five-ways-uk-and-french-differ-on-mifid-research-rules-20160930


The original MiFID has now been partly recast as the new Directive on Markets in Financial Instru-

ments (“MiFID 2”),291 and partly replaced292 by the Regulation on Markets in Financial Instruments

(“MiFIR”),293 with both the Directive and the Regulation having been in operation since 3 January

2018.294 These obligations have been further specified in the Commission Delegated Directive295

and the Commission Delegated Regulations,296 including technical standards adopted by the Eu-

ropean Commission with input and advice from the European Securities and Markets Authority

(“ESMA”).297 Collectively, we refer here to all these measures as “MiFID 2” (unless it is necessary

to differentiate amongst the Directive, the Regulation, implementing or technical standards). The

understanding of the MiFID 2 measures is aided by ESMA’s Guidelines and Q&A documents, which

are ‘a practical convergence tool used to promote common supervisory approaches and practices’

across the EU and hence contribute to the EU Single Market.298

291 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instru-

ments. 292 MiFID 2 Directive, Recital 7. This means that the effective acts are now the new (MiFID 2) Directive and the Regulation

and not the original MiFID. 293 Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial

instruments. 294 The initial implementation date of 3 January 2017 was delayed to allow for the development of the necessary IT and

other systems. 295 Commission Delegated Directive (EU) 2017/593 of 7 April 2016 supplementing Directive 2014/65/EU of the Eu-

ropean Parliament and of the Council with regard to safeguarding of financial instruments and funds belonging to

clients, product governance obligations and the rules applicable to the provision or reception of fees, commissions or

any monetary or non-monetary benefits. 296 (1) Commission Delegated Regulation (EU) 2017/565 of 25 April 2016 supplementing Directive 2014/65/EU of

the European Parliament and of the Council as regards organizational requirements and operating conditions for in-

vestment firms and defined terms for the purposes of the Directive; (2) Commission Delegated Regulation (EU)

2017/575 of 8 June 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council on mar-

kets in financial instruments with regard to regulatory technical standards concerning the data to be published by

execution venues on the quality of execution of transactions; (3) Commission Delegated Regulation (EU) 2017/576

of 8 June 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council with regard to

regulatory technical standards for the annual publication by investment firms of information on the identity of execution

venues and on the quality of execution. 297 For useful links, see ESMA Interactive Single Rulebook, available at https://www.esma.europa.eu/rules-databases-

library/interactive-single-rulebook-isrb, FIA list of the implementing standards, at https://fia.org/articles/mifid-ii-rts-

published-eu-official-journal or the UK’s Financial Conduct Authority’s list of MiFID technical standards at

https://www.fca.org.uk/publication/documents/technical-standards-under-mifid-ii-and-mifir.pdf 298 ESMA, Q & A, ‘On MiFID II and MiFIR investor protection and intermediaries topics’, (28 March 2019), p. 16.

https://www.esma.europa.eu/rules-databases-library/interactive-single-rulebook-isrb

https://www.esma.europa.eu/rules-databases-library/interactive-single-rulebook-isrb

https://fia.org/articles/mifid-ii-rts-published-eu-official-journal

https://fia.org/articles/mifid-ii-rts-published-eu-official-journal

https://www.fca.org.uk/publication/documents/technical-standards-under-mifid-ii-and-mifir.pdf


Key definitions

The definitions set out here are derived from Article 4 of MiFID 2, unless otherwise stated.

Approved publication

arrangement or APA

a person authorised under MIFID 2 Directive to provide the service of pub-

lishing trade reports on behalf of investment firms.299

Approved reporting

mechanism or ARM

a person authorised under MiFID 2 to provide the service of reporting de-

tails of transactions to domestic competent authorities or ESMA on behalf

of investment firms.300

Execution venues includes RMs, MTFs, OTFs, SIs, market makers and other liquidity provid-

ers.301 ‘Other liquidity providers’ are defined broadly,302 as including firms

‘holding themselves out as being willing to deal on their own account and

which provide liquidity as part of their normal business activity, whether

or not they have formal agreements in place or commit to providing li-

quidity on a continuous basis’. 303 A firm that regularly and consistently

provides liquidity in an instrument will be seen as meeting the definition.304

Investment firm any legal person305 whose regular occupation or business is the provision

of one or more investment services to third parties and/or the perfor-

mance of one or more investment activities on a professional basis.306 In-

vestment firms must be authorized in their home Member State.307 Na-

tional Competent Authorities as designated by Member States keep reg-

isters of all authorized investment firms and authorized activities by those

firms. 308

Investment services

and activities

any of the following services in relation to a range of financial instru-

ments:309 (a) reception and transmission of orders; (b) execution of orders

on behalf of clients; (c) dealing on own account; (d) portfolio management;

299 MiFID 2 Directive, Article 4(1)(52). 300 MiFID 2 Directive, Article 4(1)(54). 301 Commission Delegated Regulation (EU) 2017/575 of 8 June 2016 supplementing Directive 2014/65/EU of the Euro-

pean Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards

concerning the data to be published by execution venues on the quality of execution of transactions (‘RTS 27’), Recital

2. 302 RTS 27 at Recital 7. 303 MiFID 2 Directive, Recital 18. 304 ESMA, Q & A, ‘On MiFID II and MiFIR investor protection and intermediaries topics’, 28 March 2019, Section 1, Answer

18 305 It is possible for Member States, when implementing MiFID 2, to cover undertakings which are not legal persons,

see Article 4 of the MiFID 2 Directive. 306 For organizational and other requirements, including provisions on conflict of interest, relevant to investment firms,

see Commission Delegated Regulation (EU) 2017/565, Articles 21 – 76. On investor protection (including product gov-

ernance obligations, and payments of fees, commissions or other inducements in connection with provision of invest-

ment advice or research), see Commission Delegated Directive (EU) 2017/593. 307 MiFID 2 Directive, Recital 37, Articles 5 and 6. 308 MiFID 2 Directive, Article 5(3). 309 Specified in Section C of Annex 1 to the MiFID2 Directive.


(e) investment advice;310 (f) underwriting and/or placing of financial instru-

ments on a firm commitment basis; (g) placing of financial instruments

without a firm commitment basis; (h) operation of a multilateral trading

facility; (i) operation of an organized trading facility.311

Market operator a person who manages or operates the business of a regulated market and

may be the regulated market itself.

Multilateral system any system or facility in which multiple third-party buying and selling trad-

ing interests in financial instruments are able to interact in the system.

Multilateral trading

facility or MTF

a multilateral system, operated by an investment firm or a market operator,

which brings together multiple312 third-party buying and selling interests

in financial instruments – in the system and in accordance with its non-

discretionary rules – in a way that results in a contract in accordance with

MiFID 2.

Organised trading

facility or OTF

a new type of trading venue in Europe. It is a multilateral system, which is

not a regulated market or an MTF, and in which multiple third-party buying

and selling interests in bonds, structured finance products, emission allow-

ances or derivatives are able to interact in the system in a way that results

in a contract in accordance with MiFID 2.313 We do not focus on OTFs in

this report as they are not used for equities trading.

Regulated market or

RM

a multilateral system operated and/or managed by a market operator

which brings together, or facilitates bringing together, multiple third-party

buying and selling interests in financial instruments – in the system and in

accordance with its non-discretionary rules – in a way that results in a con-

tract, in respect of the financial instruments admitted to trading under its

rules and/or systems, and which is authorized or functions regularly in ac-

cordance with the terms of MiFID 2. Regulated markets are the only trad-

ing venue on which a company can conduct its primary listing.

Systematic

internalisers or SIs

a sub-category of investment firms. They deal, on an organized, frequent

systematic and substantial basis, on their own account when executing cli-

ent orders outside a regulated market, an MTF or an OTF. SIs are precluded

310 For further detail on what constitutes investment advice, see MiFID 2 Directive, Article 4(1)(4) and Commission Del-

egated Regulation 2017/565, Article 9. 311 MiFID 2 Directive, Section A of Annex 1. 312 Both MTFs and OTFs must have at least three active members or users, each having the opportunity to interact with

all the others in respect to price formation, MiFID 2 Directive, Article 18(7). 313 As the subject of this report is equity markets, OTFs will not be discussed in any great detail.


from bringing together third party buying and selling interests in function-

ally the same way as a trading venue.314 They are subject to certain obliga-

tions, additional to those that already apply to investment firms, as further

explained in this report.

Trading venue a regulated market, a multilateral trading facility, or an organized trading

facility.315

Regulated markets and multilateral trading facilities

MiFID 2, like MiFID 1, divides European trading venues into two categories for equities trading,316

namely regulated markets (“RM”) and multilateral trading facilities (“MTF”). The intent of MiFID

2 is to subject similar activities to a similar level of regulation.317 Therefore, many of the require-

ments that apply to RMs and MTFs are highly similar as both types of trading venues involve

matching trades between third parties on the basis of non-discretionary rules. The key difference

between RMs and MTFs is that companies can list on RMs but not MTFs. However, the focus of

this report is on secondary market trading, not primary listings. In this section we review the var-

ious requirements that apply to trading on RMs and MTFs.

Regulated markets need to be authorized by their competent (regulatory) authority. Authori-

zation as a regulated market is only granted where the competent authority is satisfied that both

the market operators, and the system of the regulated market, meet the requirements of the

MiFID 2 regime. Authorization may be revoked for, among other things, serious and systematic

infringements of the Directive purposes.

314 MiFID 2 Directive, Recital 17. The concept of SI is further specified in the Commission Delegated Regulation (EU)

2017/565. 315 MiFID 2 Directive, Article 4(1)(24). 316 MiFID 2 Directive, Article 4(1)(24). 317 MiFIR, Recital 8. 318 MiFID 2, Article 44. 319 Market operators need to be able to satisfy the regulatory authority of their compliance at least with the Title III of

the MiFID 2 Directive. Overall, key MiFID 2 provisions applying to market operators are MiFID 2 Directive, Article 18(1)

(applying the organizational requirements set out in Article 16) and 45; Commission Implementing Regulation (EU)

2017/1093 of 20 June 2017 laying down implementing technical standards with regard to the format of position reports

by investment firms and market operators; Commission Delegated Regulation (EU) 2017/1018. 320 MiFID 2 Directive, Article 44(1). 321 MiFID 2 Directive, Article 44(5)(d).


MTFs can only be operated by investment firms (who would need to be authorized for that par-

ticular investment activity) or market operators (who are also subject to MiFID 2 require-

ments). MTFs must provide their competent authorities with information on their rules and pro-

cedures for trading and in what instances the operation of the system will give rise to conflicts of

interest between the MTF, its operators or owners, and its functions.

Trading, access and fees

RMs and MTFs must have transparent and non-discretionary rules for fair and orderly trading,

and objective criteria for the efficient execution of orders in the system. The operators of

these systems cannot execute orders against proprietary capital or engage in matched principal

trading.

RMs and MTFs must provide transparent, fair and non-discriminatory access to market partici-

pants, which includes fee structures and co-location services. In relation to fees, trading venues

must use objective criteria when determining rebates, incentives and disincentives. Fee struc-

tures that contribute to conditions leading to disorderly trading conditions, through encouraging

intensive trading and leading potentially to a stress of market infrastructures, are prohibited.

With respect to market data fees, trading venues are required to provide market data on a “rea-

sonable commercial basis.”333 As a result, market data prices must be: (i) based on costs of pro-

322 MiFID 2 Directive, Annex I, Section A, point (8). 323 MiFID 2 Directive, Article 16 (as applied to market operators by Article 18). 324 Commission Implementing Regulation (EU) 2016/824 of 25 May 2016 laying down implementing technical standards

with regard to the content and format of the description of the functioning of multilateral trading facilities and orga-

nized trading facilities and the notification to the European Securities and Markets Authority according to Directive

2014/65/EU of the European Parliament and of the Council on markets in financial instruments (‘RTS 19’), Recital 2, and

Articles 1 – 5. 325 The terminology used in MiFID 2 is generally to impose the obligations on those who are operating the trading

venues, i.e. investment firms or market operators. See for example, MiFID 2 Directive, Article 18. 326 Conditions which would be considered non-objective and discriminatory are, for example, requiring minimum trad-

ing activity, or imposing restrictions on the number of participants that a participant can interact with in a request for

quote protocol, see ESMA, Q & A, ‘On MiFID and MiFIR market structure topics’ (1 February 2019), Section 5, Answer 3. 327 MiFID 2 Directive, Articles 47(1)(d) and 19(1). 328 MiFID 2 Directive, Articles 47(2) and 19(5). 329 For a list of EU regulated markets, see https://ec.europa.eu/info/node/7511 330 For more detail, see Commission Delegated Regulation (EU) 2017/573 of 6 June 2016 supplementing Directive

2014/65/EU of the European Parliament and of the Council on markets in financial instruments with regard to regulatory

technical standards on requirements to ensure fair and non-discriminatory co-location services and fee structures (‘RTS

10’). 331 RTS 10, supra note 330, at Recital 5. 332 RTS 10, supra note 330, at Recital 6. 333 EUROPEAN SECURITIES AND MARKETS AUTHORITY, Consultation Paper: MiFID II/MiFIR Review Report on the Development in



ket_data_and_consolidated_tape_equity.pdf.

https://ec.europa.eu/info/node/7511

https://www.esma.europa.eu/sites/default/files/library/esma70-156-1065_cp_mifid_review_report_cost_of_market_data_and_consolidated_tape_equity.pdf



ducing and disseminating such data, including a reasonable margin; (ii) offered on a non-discrim-

inatory basis to all clients; (iii) charged according to the individual end-user’s use; and (iv) available

without being bundled with other services.334

Different fee structures for the same services can only be established where those fee structures

relate to (a) the total volume traded, the number of trades or cumulated trading fees; (b) the

services or packages of services provided by the trading venue; (c) the scope or field of use de-

manded; (d) the provision of liquidity. Trading venues can adjust their fees for cancelled orders

according to the length of time for which the order was maintained and to calibrate the fees to

each financial instrument to which they apply. They can also impose higher fees for placing an

order that is subsequently cancelled than for an order which is executed; trading venues can also

impose a higher fee on participants placing a high ratio of cancelled orders to executed orders

and on those operating a high-frequency trading technique in order to reflect the additional sys-

tem use. Volume discounts can be granted, provided that they are based on the total trading

volume, the total number of trades or the cumulative trading fees generated by one member,

where only the marginal trades executed subsequent to reaching the thresholds are executed at

a reduced price. Member States are to ensure, among other things, that RM and MTF fee struc-

tures are transparent, fair and non-discriminatory.

ESMA continues to review the issue of market data fees charged by trading venues, observing

that further investigation is warranted because, since the implementation of MiFID 2, market data

costs have at times increased 400% compared to pre-implementation prices. Market partici-

pants claim that trading venues are charging fees far in excess of the costs of producing and

distributing market data, and by increasing the number of their fees (by recategorizing fees and

334 EUROPEAN SECURITIES AND MARKETS AUTHORITY, Consultation Paper: MiFID II/MiFIR Review Report on the Development in



ket_data_and_consolidated_tape_equity.pdf. 335 RTS 10, supra note 330, at Article 3. 336 MiFID 2 Directive, Article 48(9). 337 MiFID 2 Directive, Article 48(9). 338 RTS 10, supra note 330, at Recital 6. 339 MiFID 2 Directive, Article 48(9). 340 See generally, EUROPEAN SECURITIES AND MARKETS AUTHORITY, Consultation Paper: MiFID II/MiFIR Review Report on the

Development in Prices for Pre- and Post-Trade Data and on the Consolidated Tape for Equity Instruments (July 12,

2019), https://www.esma.europa.eu/sites/default/files/library/esma70-156-1065_cp_mifid_review_report_cost_of_mar-

ket_data_and_consolidated_tape_equity.pdf. 341 ESMA, ‘MiFID II Implementation – Achievements and Current Priorities’ (21 June 2018), available at

https://www.esma.europa.eu/sites/default/files/library/esma70-156-427_mifid_ii_implementation_-_achieve-

ments_and_current_priorities_steven_maijoor_fese_convention_2018_vienna_21_june_1.pdf





https://www.esma.europa.eu/sites/default/files/library/esma70-156-427_mifid_ii_implementation_-_achievements_and_current_priorities_steven_maijoor_fese_convention_2018_vienna_21_june_1.pdf

https://www.esma.europa.eu/sites/default/files/library/esma70-156-427_mifid_ii_implementation_-_achievements_and_current_priorities_steven_maijoor_fese_convention_2018_vienna_21_june_1.pdf


charging for supposedly ‘new’ products). Trading venues do not publish their cost of distrib-

uting the market data, which makes it difficult to determine whether the fees they charge are

excessive. On the other hand, one report prepared by economic consultancy Oxera for the Fed-

eration of European Securities Exchanges (FESA) claims that the aggregate market data reve-

nues of the members of FESA have only risen in recent years by around 1% per year in real terms.

In a July 2019 Consultation Paper, ESMA solicited additional feedback from market participants

on the state of market data fees and prospective improvements to market data fee regulation.

Transparency, record keeping and resiliency

As discussed in more detail in the section of this report dealing with transparency issues, MiFID 2

requires trading venues to make pre- and post-trade information available to the public on a

‘reasonable commercial basis’ and to ‘ensure non-discriminatory access to the information’.347

342 Copenhagen Economics study ‘Pricing of market data’ (commissioned by the Danish and Swedish dealers associa-

tions), November 2018. The study claims, among other things, (1) that the the fees charged by trading venues for

market data have increased by 30 – 60% in the period since 2008 (using Nasdaq Nordic Ltd as a case), while the cost of

transmitting 1 Mbps of data is now around 1/20th of what it used to be a decade ago; and (2) that MiFID 2 itself has

created opportunities for trading venues to charge further fees. See Copenhagen Economics, Pricing of Market Data (28

November 2018), available at https://www.copenhageneconomics.com/dyn/resources/Publication/publica-

tionPDF/6/466/1543587169/pricing-of-market-data.pdf 343 The Copenhagen Economics study refers to the inequity of the ‘reverse burden of proof’ practices, where users are

charged for every employee who could have had access to data, not just for those that de facto had it, and it is up to

the users to provewho had access, see pp.27-28 of the Copenhagen Economics study. See also MFA AIMA Joint Letter

to ESMA on Increased Fees for Access to Market Data, dated December 11, 2018, available at https://www.managed-

funds.org/issues-policy/mfa-comment-letters/mfa-aima-joint-letter-esma-increased-fees-access-market-data/ 344 The SEC issued guidance on May 21, 2019, as to the level of detail it expects to see from exchanges such as New

York Stock Exchange and Nasdaq, when they seek to increase the fees they charge for market data, see

https://www.sec.gov/tm/staff-guidance-sro-rule-filings-fees The details required include measuring down to the mi-

crosecond a faster data product, and showing the costs of producing data, if exchanges are using the cost as a basis

for justifying their higher fees. The move was welcomed by IEX, a stock exchange which claims that the market data

fees charged by the dominant US exchanges were 1,500 per cent times the cost of producing the data, when compared

with its own data costs. See Henderson, ‘Regulator calls on US exchanges to justify increases in data fees’ (FT, May 21,

2019) and Henderson, ‘’Flash Boys’ exchange IEX backs regulator in data fees fight’ (FT, May 14, 2019). 345 Oxera, ‘The design of equity trading markets in Europe’ (March 2019), available at https://fese.eu/app/up-

loads/2019/03/190321-The-design-of-equity-trading-markets-in-Europe-full-report.pdf This report uses the term

‘stock exchange’ (and ‘primary market’) to refer to a country’s primary stock exchange, ‘which is usually also a ‘regulated

market’ (see footnote 1, on p.1). The Copenhagen Economics report discusses trading venues more generally. 346 EUROPEAN SECURITIES AND MARKETS AUTHORITY, Consultation Paper: MiFID II/MiFIR Review Report on the Development in

Prices for Pre- and Post-Trade Data and on the Consolidated Tape for Equity Instruments (July 12, 2019),


ket_data_and_consolidated_tape_equity.pdf. 347 MiFIR, Article 13(1).

https://www.copenhageneconomics.com/dyn/resources/Publication/publicationPDF/6/466/1543587169/pricing-of-market-data.pdf

https://www.copenhageneconomics.com/dyn/resources/Publication/publicationPDF/6/466/1543587169/pricing-of-market-data.pdf

https://www.sec.gov/tm/staff-guidance-sro-rule-filings-fees

https://fese.eu/app/uploads/2019/03/190321-The-design-of-equity-trading-markets-in-Europe-full-report.pdf

https://fese.eu/app/uploads/2019/03/190321-The-design-of-equity-trading-markets-in-Europe-full-report.pdf




Trading venue operators have detailed record keeping and operating obligations. For exam-

ple, trading venues need to be able to identify orders generated by algorithmic trading; they

also have to have in place effective, systems, procedures and arrangements to ensure that their

trading systems are resilient and able to reject orders that exceed pre-determined volume and

price thresholds or are clearly erroneous, have sufficient capacity to deal with peak order and

message volumes, are able to ensure orderly trading under conditions of severe market stress, are

fully tested to ensure such conditions are met, and are subject to effective business continuity

arrangements to ensure continuity of their services if there is any failure of their trading systems.

Systematic internalisers

The definition of trading venues under MiFID 2 does not include SIs, but SIs play a significant

role in the equity markets. As part of a desire to capture, in regulatory terms, over-the-counter

(OTC) trading activity, increase transparency and ensure that the internalization of order flow does

not undermine the efficiency of price formation on trading venues, MiFID 2 provided additional

objective criteria to help investment firms determine whether they are an SI in relation to a par-

ticular financial instrument. Therefore, although the SI regulatory regime already existed under

MiFID 1,354 it assumed greater significance under MiFID 2.

An SI is an investment firm which, on an organized, frequent systematic and substantial basis, deals

on its own account when executing client orders outside a trading venue. ESMA has provided

guidance on how to apply the definition. In ESMA’s analysis, SI activity is characterized by risk-

facing transactions that impact the profit and loss account of the firm. Investment firms that

meet the definition of an SI for a particular financial instrument must notify their regulatory au-

thority, who will in turn notify ESMA.

Under MiFID 2, ‘frequent and systematic basis’ is measured by the size of OTC trades in the finan-

cial instrument carried out by the investment firm on their own account when executing client

orders; ‘substantial basis’ is measured either by the size of the OTC trading carried out by the

investment firm in relation to the total trading of the investment firm in a specific financial instru-

ment, or by the size of the OTC trading carried out by the investment firm in relation to the total

trading in the Union in a specific financial instrument. ESMA publishes quarterly data on the

348 See, for example, Commission Delegated Regulation (EU) 2017/580 of 24 June 2016 supplementing Regulation (EU)

No 600/2014 of the European Parliament and of the Council with regard to regulatory technical standards for the

maintenance of relevant data relating to orders in financial instruments (‘RTS 24’). 349 Commission Delegated Regulation 2017/565, Chapter IV. 350 MiFID 2 Directive, Article 48(10). 351 MiFID 2 Directive, Articles 48(1) and (4) and 18(5). 352 MiFID 2 Directive, Article 4(1) (24). 353 Callaghan, ‘MiFID II implementation: the Systematic Internaliser regime’ at https://www.icmagroup.org/assets/doc-

uments/Regulatory/MiFID-Review/MIFIDII-the-SystematicInternaliserRegime-060417.pdf 354 MiFID 1 Directive, Article 4(1)(7). 355 ESMA, Q&A on MiFID II and MiFIR market structure topics (1 February 2019), Section 5.3, Answer 26. 356 MiFIR, Article 15(1) 357 MiFID 2 Directive, Article 4(1) (20). For exact details of the criteria in relation to shares and equity-like instruments,

see Commission Delegated Regulation (EU) 2017/565, Article 12.

https://www.icmagroup.org/assets/documents/Regulatory/MiFID-Review/MIFIDII-the-SystematicInternaliserRegime-060417.pdf

https://www.icmagroup.org/assets/documents/Regulatory/MiFID-Review/MIFIDII-the-SystematicInternaliserRegime-060417.pdf


total level of trading and number of transactions in financial instruments and classes of instru-

ments, so that investment firms can calculate whether or not they are required to notify their

national competent authorities that they are an SI in particular instruments or classes of instru-

ment. A firm will fall under the SI regulatory regime only (i) if it crosses both the pre-set limits

for a frequent and systematic basis and for a substantial basis, or (ii) where an investment firm

chooses to opt-in under the SI regime.

With respect to SIs, MiFID 2 aims for pre-set OTC trading limits to (i) include OTC trading that

materially affect price formation but (ii) exclude smaller OTC trading for which the cost compliance

with SI requirements is disproportionate in light of the minimal effect on price formation.

The best execution obligation, described in detail later in this report, requires that investment

firms attempt to obtain the best possible results for their clients taking into account price, costs,

speed, likelihood of execution and settlement, size, nature or any other consideration relevant to

the execution of the order.361 For orders at or below standard market size, SIs are generally re-

quired to execute client orders at the SI’s quoted prices at the time of reception of the orders.362

However, when “justified,” they may execute those orders at a better price provided that the price

falls within a public range363 close to prevailing market conditions.364 ESMA considers that price

improvements would only be “justified” where they are meaningful and reflect the minimum tick

size applicable to the same financial instrument traded on a trading venue. Otherwise, according

to ESMA, marginal price improvements on quoted prices would challenge the efficient valuation

of equity instruments without bringing any real benefits to investors.365 Conversely, for orders

above standard market size, SIs can offer sub-tick price improvement.366

SIs are allowed to withdraw their quotes under exceptional market circumstances (such as where

there are trading halts or suspensions from trading). In order to limit their counterparty expo-

sure, SIs are also allowed to limit in a non-discriminatory way the number of transactions from the

same client which they undertake to enter at the published conditions, or to limit the total number

358 FCA, ‘Supervisory Statement on the Operation of the MiFID Transparency Regime post-Brexit’ (14 March 2019), Para

34. 359 MiFID 2 Directive, Article 4(1)(2). 360 Commission Delegated Regulation (EU) 2017/565, Recital 18. 361 MiFID 2 Directive, Article 27 (1). 362 MiFIR, Article 15(2) (“Systematic internalisers shall… execute the orders they receive from their clients… at the quoted

prices at the time of reception of the order.”); MiFIR, Article 14(2) (exempting orders above standard market size from

the execution requirements in Article 15). 363 MiFIR, Article 15(2) and (3); Commission Delegated Regulation (EU) 2017/567, Article 14(3) – (5). A price will fall

within a public range close to market conditions where it is within the bid and offer quotes of the SI and those quotes

reflect prevailing market conditions. 364 Ibid. There are specific provisions for orders from professional clients in respect of transactions where execution in

several securities is part of one transaction, where orders are subject to conditions other than the current market price;

or where an SI receives an order of a size bigger than its quotation size but lower than the standard market size, MiFIR,

Article 15(3) and (4). 365 ESMA, Q & A, ‘On MiFID II and MiFIR market structure topics’ (1 February 2019), Section 5, Answer 29. 366 MiFIR, Article 14(2) (exempting orders above standard market size from certain execution requirements). 367 MiFIR, Article 15(1); Commission Delegated Regulation (EU) 2017/567, Article 14(1).


of transactions from different clients at the same time where the number and/or volume of the

orders exceeds the norm.

MiFID 2 imposes requirements for (a) pre-trade transparency and (b) post-trade transparency and

regulatory reporting. With respect to post-trade information, MiFID 2 requires both: (1) cer-

tain post-trade transparency to the public (trade reporting) and (2) post-trade disclosures to reg-

ulators (transaction reporting).

Pre-trade transparency is to be provided on a continuous basis, throughout normal trading hours.

Post-trade trade reporting to the public must be done in real time to support the accurate for-

mation of prices. Transaction reporting to regulators must be completed no later than the close

of business on the business day following the execution day. Regulators collect transaction reports

in order to monitor markets and supervise for manipulation of financial markets or other market

abuses.

Pre-trade transparency

In terms of pre-trade transparency, trading venues (i.e. RMs, MTFs) must make public current

bid and offer prices, and the depth of trading interests (including actionable indications of inter-

est) at those prices, which are advertised through their systems for shares and other equity-like

instruments. Those transparency requirements are calibrated for different types of financial in-

struments (taking into account the interests of investors and issuers, and market liquidity) and

different trading systems (taking account of transaction size, and other relevant criteria). The

information is to be made available to the public on a reasonable commercial basis, with non-

368 MiFIR, 17(2); on what exceeds the ‘norm’, see Commission Delegated Regulation (EU) 2017/567, Article 15. 369 This is a MiFID term; it can also be called ‘quotation data.’ See CCMR, ’The US Equity Markets Report’ (July 2016),

p.xxiii. 370 This can also be referred to as ‘execution data’. 371 See also ESMA, Q& A on MiFID II and MiFIR on transparency issues (1 February 2019), and MiFID 2 technical stand-

ards, in particular Commission Delegated Regulation (EU) 2017/587 of 14 July 2016 supplementing Regulation (EU) No

600/2014 of the European Parliament and of the Council on markets in financial instruments with regard to regulatory

technical standards on transparency requirements for trading venues and investment firms in respect of shares, depos-

itary receipts, exchange-traded funds, certificates and other similar financial instruments and on transaction execution

obligations in respect of certain shares on a trading venue or by a systematic internaliser (‘RTS 1’), and Commission

Delegated Regulation (EU) 2017/577 of 13 June 2016 supplementing Regulation (EU) No 600/2014 of the European

Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards on the

volume cap mechanism and the provision of information for the purposes of transparency and other calculations (‘RTS

3’). 372 Strictly speaking, the obligation is imposed on ‘market operators’ (i.e. those who manage and/or operate a regulated

market, and may be the regulated market themselves, MiFID 2 Directive, Article 4 (1)(18)) and investment firms operating

a trading venue, RTS 1, Article 3(1). 373 MiFIR, Article 3(1); RTS 1, Article 3. This is subject to waivers set out in Article 4, see further below. 374 MiFIR, Article 3(2), Recital 16. 375 On the parameters for determining what is ‘reasonable commercial basis’ for both trading venues and SIs, see Com-

mission Delegated Regulation (EU) 2017/565, Articles 6 and 7.


discriminatory access, and disaggregated from other services. The information is to be free

of charge 15 minutes after publication. However, due to continuing low levels of compliance,

ESMA issued guidance in July 2019 to discourage practices that were inconsistent with the obli-

gation to make information available free of charge (including access restrictions, the use format-

ting that is not machine-readable, and deleting data shortly after publication).379

Likewise, for orders at or below the standard market size, SIs need to make public and easily

accessible on a continuous basis during normal trading hours firm two-way quotes in respect

of shares and equity-like instruments for which (i) they are SIs and (ii) there is a liquid market.

“Standard market size” is the average value of transactions for each financial instrument over the

preceding year in the EU, subject to certain adjustments.383 Any restrictions they impose on access

to that information could be based on commercial policy (distinguishing for example between

different categories of clients) but needs to be done in an objective non-discriminatory man-

ner. Where there is no liquid market, SIs are only required to disclose quotes to their clients

upon request. Quotes are to be made public in a manner which is easily accessible to other

market participants on a reasonable commercial basis.

National competent authorities have discretion to waive the obligation for trading venues to dis-

close the above pre-trade information. There are four types of such waivers (all discussed in further

detail in the section on ‘Dark v lit trading’): (1) the reference price waiver; (2) the negotiated

trade waiver; (3) the large in scale waiver; and (4) the order management facility. Waivers

376 On the meaning of ‘non-discriminatory’ in this context, see Commission Delegated Regulation (EU) 2017/567, Article

8. 377 Commission Delegated Regulation (EU) 2017/567, Article 10. 378 MiFIR, Article 13. 379 EUROPEAN SECURITIES AND MARKETS AUTHORITY, Q&A: On MiFID and MiFIR Transparency Topics, 25-27 (July 12, 2019),

https://www.esma.europa.eu/sites/default/files/library/esma70-872942901-35_qas_transparency_issues.pdf. 380 On the meaning of which see Commission Delegated Regulation (EU) 2017/567, Article 13. 381 MiFIR, Article 15. Commission Delegated Regulation (EU) 2017/567, Article 12. 382 MiFIR, Article 14; RTS 1, Articles 9 and 10. 383 Comission Delegated Regulation (EU) 2017/587, Article 11 (July 14, 2016); Article 14(2) and (4) of Regulation (EU)

No 600/2014. 384 MiFIR, Recital 21. 385 Commission Delegated Regulation (EU) 2017/567, Article 17. 386 MiFIR, Article 14(1). 387 MiFIR, Article 15(1). 388 MiFIR, Article 4. 389 On the requisite calculations for this waiver, see RTS 1, Article 4. 390 On the specific characteristics required for this waiver to apply, see RTS 1, Articles 5 and 6. 391 On further details for this waiver, see RTS 1, Article 7. 392 On further details for this waiver, see RTS 1, Article 8.


are seen as ensuring an appropriate balance between transparency and liquidity in equities mar-

kets. Both the ESMA and various national regulators have issued guidance on waiver applica-

tions.

Pre-trade and post-trade transparency data is to be made available by the trading venue and SIs

separately. ESMA has specified the level of disaggregation of that data (data is to be disaggre-

gated by asset class, by country of issue, by the currency in which a financial instrument is traded,

and according to whether data comes from scheduled daily auctions or from continuous trad-

ing).

Post-trade disclosure to regulators: transaction reporting

Investment firms that execute transactions397 in financial instruments398 need to report to regula-

tors the complete and accurate details of such transaction no later than the first business day

following execution,399 with each report needing to include 65 data fields (increased from 23 fields

under MiFID 1).400 These transaction reports are collected in order to prevent the manipulation of

financial markets, or other market abuse.401

The reports have to identify both the client and the trader or algorithm responsible for the invest-

ment decision and execution, so investment firms that receive and transmit orders have to include

such details in any orders they transmit, unless they wish to report such orders themselves.

The reports essentially cover every stage of the trade, from the portfolio investment decision,

initial indication of interest and order management right through to execution. One major

393 UK FCA, ‘MiFID background and MiFID 2 objectives’, Chapter 6 (Transparency), available at

https://www.fca.org.uk/mifid-ii/6-transparency (visited on April 1, 2019). 394; ESMA, Q&A on MiFID II and MIFIR transparency topics (1 February 2019); and see for example, in the UK, FCA, ‘MiFID

II – Application and notification user guide’, January 2017. 395 MiFIR, Article 12. 396 Commission Delegated Regulation (EU) 2017/572 of 2 June 2016 supplementing Regulation (EU) No 600/2014 of

the European Parliament and of the Council with regard to regulatory technical standards on the specification of the

offering of pre- and post- trade data and the level of disaggregation of data (‘RTS 14’), Article 1. 397 The meaning of a transaction for reporting purposes is broad. It covers purchases and sales of reportable instru-

ments, as well as other cases of acquisitions or disposals of reportable instruments. For further details, see Commission

Delegated Regulation (EU) 2017/590 of 28 July 2016 supplementing Regulation (EU) No 600/2014 of the European

Parliament and of the Council with regard to regulatory technical standards for the reporting of transactions to com-

petent authorities (‘RTS 22’), Recital 2, Article 2. 398 For detail of reference data that needs to be provided by trading venues and SIs, see Commission Delegated Regu-

lation (EU) 2017/585 of 14 July 2016 supplementing Regulation (EU) 600/2014 of the European Parliament and of the

Council with regard to regulatory technical standards for the data standards and formats for financial instrument refer-

ence data and technical measures in relation to arrangements to be made by the European Securities and Markets

Authority (‘RTS 23’). 399 MiFIR, Article 26. 400 MiFIR, Article 26; RTS 22, Table 2 of Annex I. 401 Explanatory Memorandum to the Data Reporting Services Regulation 2017 (SI 699/2017), para 7.7. 402 MiFIR, Article 26(4) 403 EY, ‘MiFID II – The front office impact’, p. 6, available at https://www.ey.com/Publication/vwLUAssets/ey-mifid-ii-the-

front-office-impact/$FILE/ey-mifid-ii-the-front-office-impact.pdf

https://www.fca.org.uk/mifid-ii/6-transparency

https://www.ey.com/Publication/vwLUAssets/ey-mifid-ii-the-front-office-impact/$FILE/ey-mifid-ii-the-front-office-impact.pdf

https://www.ey.com/Publication/vwLUAssets/ey-mifid-ii-the-front-office-impact/$FILE/ey-mifid-ii-the-front-office-impact.pdf


change that MiFID 2 has brought is the mandatory introduction of Legal Entity Identifiers (LEIs) –

unique 20-digit alpha-numeric codes identifying legal entities or structures trading on EU markets,

which are included in a global data system and enable every legal entity that is a party to a relevant

financial transaction to be identified, no matter where it is located. All entities trading with

European counterparties across all asset classes must obtain LEIs. There was an extension of

the initial deadline for compliance, but the grace period for all legal entities involved in executing

trades to obtain LEIs ended on July 2, 2018.

Under MiFID I, transaction reporting applied only to shares trading on an RM. The requirements

have been extended to all trading venues and to all financial instruments that are admitted to

trading on a trading venue, even if trades take place outside the trading venue. Transaction

reporting requirements are calibrated for different types of instruments and different types of

trading.

Transaction reporting can be made by the investment firm, an Approved Reporting Mechanism

(“ARM”) acting on its behalf, or by the trading venue through whose system the transaction was

completed. Alternatively, reporting to a trade repository under EMIR satisfies the obliga-

tion. The responsibility for the accuracy, completeness and timely submission of the transaction

reports lies with the investment firms (except where the failure is attributable to the ARM or the

trading venue which is submitting the report, but even then investment firms must take reasona-

ble steps to verify those reports).

404 ‘MiFID II and the fight against financial crime’, speech by Mark Steward, FCA Director of Enforcement and Market

Oversight, 3 July 2018. 405 LEIs are issued by ‘Local Operating Units’ of the Global LEI System, for more detail see https://www.lei-

roc.org/lei/how.htm 406 ESMA Statement on LEI requirements under MiFIR (20 June 2018), available at https://www.esma.europa.eu/sites/de-

fault/files/library/esma70-145-872_public_statement_on_lei.pdf 407 https://www.lexisnexis.com/uk/lexispsl/financialservices/document/393813/5MM4-8TS1-F18F-M04H-00000-

00/MiFID_and_MiFID_II_overview 408 For transactions that are within reporting requirements of Article 26 of the MiFIR. 409 RTS 1, Recital 6; see also ESMA, Q & A, On MiFID II and MiFIR transparency topics (1 February 2019). 410 MiFIR, Article 26(7). 411 Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC Derivatives,

Central Counterparties and Trade Repositories (referred to as the European Market Infrastructure Regulation or EMIR). 412 https://www.nortonrosefulbright.com/knowledge/publications/abde0e6a/mifid-ii-mifir-series 413 For an example of the potential consequences of transaction reporting failures, see the UK Financial Conduct Au-

thority £27.6m fine of UBS AG, for 135.8m reporting errors over 9.5 years, including the failure to provide complete and

accurate information on 86.67m reportable transactions, https://www.fca.org.uk/news/press-releases/fca-fines-ubs-ag-

276-million-transaction-reporting-failures (March 19, 2019) 414 MiFIR, Article 26(7)

https://www.leiroc.org/lei/how.htm

https://www.leiroc.org/lei/how.htm

https://www.esma.europa.eu/sites/default/files/library/esma70-145-872_public_statement_on_lei.pdf

https://www.esma.europa.eu/sites/default/files/library/esma70-145-872_public_statement_on_lei.pdf

https://www.lexisnexis.com/uk/lexispsl/financialservices/document/393813/5MM4-8TS1-F18F-M04H-00000-00/MiFID_and_MiFID_II_overview

https://www.lexisnexis.com/uk/lexispsl/financialservices/document/393813/5MM4-8TS1-F18F-M04H-00000-00/MiFID_and_MiFID_II_overview

https://www.nortonrosefulbright.com/knowledge/publications/abde0e6a/mifid-ii-mifir-series

https://www.fca.org.uk/news/press-releases/fca-fines-ubs-ag-276-million-transaction-reporting-failures

https://www.fca.org.uk/news/press-releases/fca-fines-ubs-ag-276-million-transaction-reporting-failures


Post-trade transparency to the public: trade reporting

The post-trade public transparency obligation is often referred to as ‘trade reporting’.415 It applies

to trading venues416 and investment firms trading outside the rules of a trading venue (including

SIs).417 The purpose of trade reporting is to support efficient price formation.418

The obligation requires that trading venues and investment firms make public the price, volume

and time of the executed transactions in shares (and other equity-like instruments)419 as close to

real time as is technically possible.420 The information is to be made public directly (by trading

venues) and through an Approved Publication Arrangement (“APA”) (for SIs and other investment

firms).421 The information is to be made available to the public on a reasonable commercial basis,

with non-discriminatory access.422 It also must be offered free of charge 15 minutes after publi-

cation,423 but compliance with the latter obligation has been limited and inconsistent.424

Where a transaction between two investment firms is concluded outside the rules of a trading

venue, either on own account or on behalf of clients, only the selling firm shall make the disclosure

(unless only one of them is a systemic internaliser and that firm is a buyer, in which case the buyer

will make the disclosure).425

Trade reporting requirements are subject to the possibility of a deferral of disclosure for transac-

tions that are large in scale compared to normal market size (block trades), if authorized to do

so by the national competent authority. The existence of deferred trade-publication arrangements

is to be clearly disclosed to market participants and the public.

Data reporting service providers

Data reporting service providers must be authorized under MiFID 2 and are thereafter subject to

ongoing compliance duties,427 in particular with regard to the existence and management of any

conflicts of interest. There are three different kinds of data providers (“DRSP”) under MiFID 2, all

415 See, for example, UK FCA, ‘Supervisory Statement on the Operation of the MiFID Transparency Regime post-Brexit’

(March 14, 2019), paras 38 – 41. 416 Strictly speaking, the obligation is imposed on ‘market operators’ (i.e. those who manage and/or operate a regulated

market, and may be the regulated market themselves, MiFID 2 Directive, Article 4 (1)(18) and investment firms operating

a trading venue, RTS 1, Article 3(1). 417 RTS 1, Article 12(1). 418 Explanatory Memorandum to the (UK) Data Reporting Services Regulation 2017 (SI 699/2017), para 7.5. 419 MiFIR, Articles 6 (requirements for trading venues) and 20 (requirements for investment firms, including SIs); for the

details of the reporting format, see RTS 1, Articles 12 and 13. 420 On the meaning of ‘real time’, see RTS 1, Article 14. 421 MiFID 2 Directive, Article 64. 422MiFIR, Article 13. 423MiFIR, Article 13. 424 EUROPEAN SECURITIES AND MARKETS AUTHORITY, Q&A: On MiFID and MiFIR Transparency Topics, 25-27 (July 12, 2019),

https://www.esma.europa.eu/sites/default/files/library/esma70-872942901-35_qas_transparency_issues.pdf (advising

against practices inconsistent with the obligation because they were common). 425 RTS 1, Article 12 (4) and (5). 426 MiFIR, Article 7; see RTS 1, Article 15, for more details on the size and the period of deferral. 427 See for example Commission Delegated Regulation 2017/565, Chapter VI.

https://www.esma.europa.eu/sites/default/files/library/esma70-872942901-35_qas_transparency_issues.pdf


independent entities, which must be authorized by the relevant the National Competent Authority

in each Member State (that authorization then allows them to provide services throughout the

EU).428 The three types of DRSPs are: Approved Reporting Mechanisms (“ARM”), Approved Publi-

cation Arrangements (“APA”), and Consolidated Tape Providers (“CTP”).

ARMs enable investment firms to meet their transaction reporting obligations429 by reporting de-

tails of transactions to competent authorities (in the UK, for example, that is the FCA) or to ESMA,

no later than the close of the working day following the day on which the transaction took place.430

As set out above, transaction reports are collected in order to prevent the manipulation of financial

markets or other market abuse.431

APAs enable investment firms to meet their trade reporting obligations by making public the

relevant details of the trades as close to real time as is technically possible.432 The information

must be published on a reasonable commercial basis, and after 15 minutes without charge. The

publication of this information is part of the MiFID 2 transparency regime intended to support the

accurate formation of prices.433 However, the market has not yet achieved widespread compli-

ance.434

CTPs collect trade reports435 for financial instruments from trading venues and APAs, and they

then consolidate them into a continuous electronic live data stream providing price and volume

data for each financial instrument. The data stream is to be made available to the public on a

reasonable commercial basis.436

In the UK, for example, there are currently six DRSPs authorized, 437 two as only APAs and four as

both APAs and ARMs.438

428MiFID 2 Directive, Articles 59(1) and 60(2). Commission Delegated Regulation (EU) 2017/571 of 2 June 2016 supple-

menting Directive 2014/65/EU of the European Parliament and of the Council with regard to the regulatory technical

standards on the authorization, organizational requirements and the publication of transactions for data reporting ser-

vices providers (‘RTS 13’) sets out detailed requirements relating to authorization, organizational requirements, and

publication arrangements. 429 MiFID 2 Directive, Article 66. 430 MiFID 2 Directive, Article 66; MiFIR, Article 26. 431 Explanatory Memorandum to the (UK) Data Reporting Services Regulation 2017 (SI 699/2017), para 7.7. 432 MiFID 2 Directive, Article 64(1); MiFIR, Article 20. 433 Explanatory Memorandum to the (UK) Data Reporting Services Regulation 2017 (SI 699/2017), para 7.5. 434 See, e.g., EUROPEAN SECURITIES AND MARKETS AUTHORITY, Q&A: On MiFID and MiFIR Transparency Topics, 25-27 (July 12,

2019), https://www.esma.europa.eu/sites/default/files/library/esma70-872942901-35_qas_transparency_issues.pdf. 435 MiFID 2 Directive, Article 65(1). 436 Explanatory Note to the (UK) Data Reporting Services Regulation 2017 (SI 699/2017). 437 For the UK implementation of MiFID 2 in relation to DRSPs, see in particular The Data Reporting Services Regulations

2017 (SI 2017 No. 699). The UK government was concerned about the circularity of MiFID 2 definitions of these services,

but has adopted a ‘direct copy out approach’ to avoid the risk of transposing the relevant provisions incorrectly or

differently from the other Member States, see UK HM Treasury, ‘Transposition of the Markets in Financial Instruments

Directive II: response to the consultation’ (February 2017), section 3. 438 For the full list, see https://www.fca.org.uk/markets/data-reporting-services-providers-drsps/authorised-drsps

https://www.fca.org.uk/markets/data-reporting-services-providers-drsps/authorised-drsps


No CTPs have emerged in Europe following the implementation of MiFID 2. While MiFID 2 sets

out the legal framework for operating voluntary consolidated tapes, it anticipates rather than di-

rectly mandates their creation. However, it also sets forth a mechanism to review and revisit the

framework to ensure CTPs do eventually emerge.439 Although an EU-wide CTP would improve

efficiency by consolidating all post-trade information into one place and format, ESMA has found

that there are few commercial rewards for operating a consolidated tape, the CTP regulatory

framework is too restrictive, and CTP’s would face stiff competition from unregulated entities.440

As a result, it is currently uneconomical for a commercial organization to undertake the required

data processing and cleaning.441 In its July 2019 report on trading costs and market data, ESMA

concluded that the successful establishment of a pan-European CTP would require, among other

things: (i) the mandatory reporting of post-trade data by trading venues and APAs; and (ii) the

mandatory of consolidated market data by investment firms.442

Dark trading refers to trading in equities without pre-trade transparency, where the price and

volume of orders are hidden and anonymous. 443 Dark trading in the EU can take place across

different execution venues, including Regulated Markets, MTFs and SIs. Execution venues can al-

low for both lit and dark trading.444 Dark trading generally involves matching trades through a

reference price system. Typically, the reference price for dark trading is based on the best bid and

offer on the primary Regulated Market, known as the Primary Best Bid and Offer (PBBO) (for shares

in the UK, this is the London Stock Exchange). Alternatively, reference prices can also incorporate

the best bid and offer prices at other lit venues, with this typically labelled as the European Best

439 EUROPEAN SECURITIES AND MARKETS AUTHORITY, Consultation Paper: MiFID II/MiFIR Review Report on the Development in



ket_data_and_consolidated_tape_equity.pdf. 440 Id. at 30-33. 441 Blackrock, Viewpoint, ‘Mark-to-market structure: An end-investor perspective on the evolution of developed equity

markets’ (February 2019). BlackRock is of the view that ESMA is well placed to take the lead in providing a pan-European

consolidated tape solution. As BlackRock points out, a consolidated tape of post-trade information discloses execution

quantities and prices in a timely manner after trades occurred (with the exception of large-in-size waiver); that real time

trade information then strengthens price discovery and optimal venue choice, in line with best execution obligations,

as well as promoting investor confidence and execution quality generally. 442 EUROPEAN SECURITIES AND MARKETS AUTHORITY, Consultation Paper: MiFID II/MiFIR Review Report on the Development in

Prices for Pre- and Post-Trade Data and on the Consolidated Tape for Equity Instruments, 48-49 (July 12, 2019),


ket_data_and_consolidated_tape_equity.pdf. 443 FCA, ‘Catching a falling knife: an analysis of circuit breakers in UK equity markets’, 03/08/2017, available at

https://www.fca.org.uk/publications/research/analysis-circuit-breakers-uk-equity-markets 444 See, Comerton-Forde, C. 2017, ‘Shedding Light on dark trading in Europe’, CEPR-Imperial-Plato Inaugural Market

Innovator (MI3) Conference, Table III. An example is Turquoise, which is an MTF that has two electronic orders book

services, Turquoise Lit (combining limit and iceberg orders with LIS hidden orders) and Turquoise Plato (previously

called Turquoise Midpoint Dark). For detail see https://www.lseg.com/markets-products-and-services/our-markets/tur-

quoise/turquoise-trading-services (visited on March 29, 2019).





https://www.fca.org.uk/publications/research/analysis-circuit-breakers-uk-equity-markets

https://www.lseg.com/markets-products-and-services/our-markets/turquoise/turquoise-trading-services

https://www.lseg.com/markets-products-and-services/our-markets/turquoise/turquoise-trading-services


Bid and Offer (EBBO)445. As can be seen from this description, the process of determining reference

price may differ between execution venues, leading potentially to differences in execution

prices.446

Pre-trade transparency waivers

The key regulatory issue relevant to dark trading is the requirement for pre-trade transparency

for trading in stocks. In 2007, the original MiFID introduced the concept of pre-trade transparency

waivers. This meant that, in situations where waivers applied, bid and offer prices did not need to

be published by the trading venue before an order was executed (in other words dark trading

could take place). Dark trading existed prior to MiFID I through over the counter trading or special

hidden order types on exchanges, but following the introduction of the waivers, dark trading vol-

umes increased.447

MiFID 2 also provides for pre-trade transparency waivers, although with some changes in their

definitions. The four waivers under MiFID 2 are: the reference price waiver, the negotiated trade

waiver, the large in scale waiver, and the order management facility waiver.448

As previously described, the “reference price waiver” allows for trades to take place without the

public display of price or size, so long as the price is determined with reference to the publicly

displayed price for that stock on the primary listing exchange or the most relevant market in terms

of liquidity.449 The scope of this waiver has been narrowed under MiFID 2. Reference price trades

are now only allowed at the midpoint between the best bid and offer, while previously they were

allowed at the bid and offer. 450 If a trade is taking place outside of trading hours and the midpoint

price is not available, the opening or closing price of the trading session can be used.451

The “negotiated trade waiver” allows for trades to take place without the public display of price

or size, so long as members or participants of a trading venue privately negotiate the terms of a

transaction, which is then reported under the rules of the trading venue.452 There are three types

445 This is not an equivalent to the US ‘National Best Bid and Offer’ (NBBO); these are self-calculated and there is no

prescribed standard. There is a view that pre-trade transparency in the EU could be strengthened via an EU equivalent

to the US NBBO, as good pre-trade transparency would facilitate optimal order routing and compliance with best exe-

cution obligations (in addition to mitigating any concerns that SI activity is detrimental to price discovery), see

BlackRock, Viewpoint, February 2019. 446 Petrescu and Wedow ‘Dark pools in European equity markets: emergence, competition and implications’ (ECB, Oc-

casional Paper Series, No. 193, July 2017), available at https://www.ecb.europa.eu/pub/pdf/scpops/ecb.op193.en.pdf,at

p.30. 447 Petrescu and Wedow (2017), at p. 8. This paper also discusses the effect of US regulation on the increase of dark

trading in the US, see pp. 20-21. 448 MiFIR, Article 4. 449 MiFIR, Article 4(1)(a). 450 Comerton-Forde, C. 2017, ‘Shedding light on dark trading in Europe, CEPR-Imperial-Plato Inaugural Market Innova-

tor (MI3) Conference p. 8; ‘The future of dark liquidity in Europe’, Automated Trader Magazine Issue 41 Q4 2016,

http://www.automatedtrader.net/articles/strategies/156769/the-future-of-dark-liquidity-in-europe; 451 MiFIR, Article 4(2). 452 FIA Europe (report drafted by the London office of Covington & Burley LLP), ‘Special Report Series: Transparency’ (3

July 2014), available at https://fia.org/articles/special-report-series-transparency

https://www.ecb.europa.eu/pub/pdf/scpops/ecb.op193.en.pdf

http://www.automatedtrader.net/articles/strategies/156769/the-future-of-dark-liquidity-in-europe

https://fia.org/articles/special-report-series-transparency


of negotiated trades that qualify for the waiver. First, trades that are made within the current

volume weighted spread reflected on the order book, or the quotes of the market makers of the

trading venue operating that system. Second, trades in illiquid shares dealt within a percentage

of a suitable reference price (the percentage and the reference price being set in advance by the

system operator). Third, trades that are subject to conditions other than the current market

price.453

The “large in scale waiver,” or “LIS waiver,” allows for trades to take place without the public

display of price or size, so long as orders are sufficiently large in size compared with normal market

size.454 The minimum size thresholds are set with reference to average daily turnover for the fi-

nancial instrument in question.455

The “order management facility waiver” allows for trades to take place without the public dis-

play of price or size, so long as orders have been held in an order management facility of the

trading venue pending disclosure.456 Order management facilities enable investment firms to

break up large client orders into smaller orders for execution on a trading venue. Doing so is

intended to reduce the price impact of these large orders.457

Double volume caps

MiFID 2 introduced the double volume cap mechanism (“DVC”) to limit the amount of dark trad-

ing in equities allowed under two of the waivers, namely the reference price waiver and the first of

the three types of the negotiated trade waiver. 458 459 MiFID 2 also changed the size thresholds for

the use of the LIS waiver, lowering them for low volume stocks, and increasing them for the most

active stocks in the market.460 The double volume caps only apply to transactions executed on

multilateral trading venues (i.e. RMs, MTFs) but not to OTC or SI transactions.461

The first DVC cap applies to the total amount of dark trading per venue. It limits the percentage of

trading in a financial instrument carried out on any individual trading venue under the reference

453 MiFIR, Article 4(1)(b). It is important to differentiate amongst them, as the double volume cap mechanism applies

only to the first one. 454 MiFIR, Article 4(1)(c). 455 For the latest ESMA calculations published on March 6, 2019, see https://www.esma.europa.eu/press-news/esma-

news/mifid-ii-esma-makes-available-results-annual-transparency-calculations-equity 456 MiFIR, Article 4(1)(d). 457 Gladwin, ‘MiFID II: How Can Caps on Dark Pools be Implemented When There is No Consolidated Tape?’ (December

19, 2013), available at https://www.bloomberg.com/professional/blog/in-the-news-mifid-dark-pools/ 458 ESMA Report on Trends, Risks and Vulnerabilities (28 February 2019), p. 55. 459 Illiquid or transactions that are subject to other conditions do not contribute to the price formation process, and the

whole point of the DVC is to avoid negative impact on the price formation process, Recital 17 to the MiFIR. 460 Comerton-Forde (2017), p. 8; for latest LIS calculations, see ESMA, https://www.esma.europa.eu/sections/mifid-ii-

transparency-calculations-and-dvc; Under the original MiFID, RMs were also using the LIS waiver, but that waiver has

become even more important in the market place, due to the introduction of the double volume caps. LSEG, ‘MiFID II:

Six months on, six industry insights’, available at http://www2.londonstockexchangegroup.com/mifidii-insights , page

4. 461 Ulrich Nogel, ‘MiFID 2 double volume caps – the end of dark trading?’ available at http://www.automated-

trader.net/articles/strategies/158441/mifid-2-double-volume-caps-_-the-end-of-dark-trading

https://www.esma.europa.eu/press-news/esma-news/mifid-ii-esma-makes-available-results-annual-transparency-calculations-equity

https://www.esma.europa.eu/press-news/esma-news/mifid-ii-esma-makes-available-results-annual-transparency-calculations-equity

https://www.bloomberg.com/professional/blog/in-the-news-mifid-dark-pools/

https://www.esma.europa.eu/sections/mifid-ii-transparency-calculations-and-dvc

https://www.esma.europa.eu/sections/mifid-ii-transparency-calculations-and-dvc


price waiver and the first negotiated price waiver to 4% of the total volume traded in that instru-

ment on all trading venues in the EU over the previous 12 months.

The second cap applies to overall dark trading. It limits the percentage of dark trading in a financial

instrument carried out under the reference waiver and the first negotiated price waiver to 8% of

the total volume traded in that financial instrument on all trading venues in the EU over the pre-

vious 12 months.462

If a trading venue reaches the first cap, then the use of the two waivers in question on that venue

for that instrument is suspended for six months. If the EU wide limit for the instrument is reached

(the second cap), then the use of both waivers for that instrument is suspended for all trading

venues for six months.463 The trading of the respective stock is suspended by the national com-

petent authority within two working days for either the respective trading venue, or all trading

venues, depending on which cap has been triggered,464 based on ESMA’s previous month’s pub-

lished calculations.465 ESMA performs its calculations over a twelve-month rolling period and pub-

lishes the data on its website, in the Double Volume Cap Register.466

The DVC does not apply to a share for which there is no liquid market.467 There is no liquid market

if: i) the free float is less than EUR 100 million for shares admitted to trading on a regulated market

and less than EUR 200 million for shares that are only traded on MTFs; ii) the average daily number

of transactions in the share is less than 250; iii) the average daily turnover for the share is less than

EUR 1 million.468

Impact of double volume caps

By June 2018, the DVC resulted in the suspension of dark trading of more than 900 financial in-

struments, mostly shares.469 As of September 2018, the application of the DVC resulted in the

suspension of dark trading for more than 1,200 instruments, again mainly equities.470

The first set of restrictions expired in September 2018.471 In its first detailed report on the impact

of the rules (in February 2019),472 ESMA said that, for the equities banned by the DVC mechanism

in March 2018 and for which the ban ended in November 2018, the volume of trading executed

462 On reporting requirements (by trading venues, CTPs and national competent authorities), see RTS 3, Articles 6 and

7. 463 MiFIR, Article 5. Petrescu and Wedow (2017), at p. 15. 464 MiFIR Articles, 5(2) and 5(3) 465 ESMA Report on Trends, Risks and Vulnerabilities (28 February 2019), p. 55. Where the calculations show that the

trading volumes are approaching either the per venue, or the overall venues, limit, ESMA publishes another report for

the instrument within 5 days of the 15th of the calendar month, MiFIR Article 5(5). 466 See https://www.esma.europa.eu/double-volume-cap- mechanism 467 MiFIR Article 5. 468 Commission delegated regulation (EU) 2017/567, Article 1. 469 ESMA FESE Convention 2018, Speech by Steven Maijoor, 21 June 2018, available at esma70-156-427_mifid_ii_imple-

mentation_-_achievements_and_current_priorities_steven_maijoor_fese_convention_2018_vienna_21_june.pdf 470 ESMA, Report on Trends, Risks and Vulnerabilities (28 February 2019), p. 55 471 Ibid, p. 54. 472 Ibid.


in dark trading fell to less than 1 percent of the total traded in August 2018 (from 7 percent in

January 2018). The report expressed a view that conditions in lit exchanges improved while the

caps were in place, with the size of bid-ask spreads tightening, and breadth and depth improving,

but worsened when measured by the turnover ratio and average trade size.473

When executing client orders, investment firms must choose among multiple execution venues

and the best execution obligation informs their routing decisions.

Article 27 of the MiFID 2 Directive introduced a new requirement for investment firms to take ‘all

sufficient steps’ (not just ‘all reasonable steps’) to obtain, when executing orders, the best possible

results for their clients, taking into account price, costs, speed, likelihood of execution and settle-

ment, size, nature or any other consideration relevant to the execution of the order (or “best exe-

cution”).474 ESMA has specifically stated that ‘the requirement for ‘sufficient’ steps sets a higher

bar for compliance than ‘reasonable’ steps.475

In addition, Article 23 of the MiFIR Directive requires investment firms to ensure that the trades

that they undertake are in shares admitted to trading on a regulated market or traded on a trading

venue take place on a regulated market, multilateral trading facility, systematic internaliser, or

third-country trading venue assessed as equivalent by the EU.476 The European Commission has

issued equivalence determinations with respect to trading venues in the United States,477 Hong

Kong,478 and Switzerland.479

In the context of best execution, one can distinguish between the actions and processes involved

in achieving best execution, on the one hand, and the reports and records that need to be avail-

able to evidence that execution, on the other. For clarity, these execution-related reports are

different from and additional to the transaction reports to regulators discussed above.

Actions and processes

Investment firms have to ensure that the intended outcomes for their clients can be achieved

successfully on an ongoing basis. This does not mean that the firm must be able to obtain the

best possible price for its clients on every single occasion. It means that the firms will need to have

473 Ibid, p. 61. 474 This is subject to any specific instruction from the client to execute in accordance with that instruction. 475 ESMA, Q & A, ‘On MiFID II and MiFIR investor protection and intermediaries topics’, (28 March 2019, Section 1,

Answer 1. 476 MiFIR Directive, Article 23 (May 15, 2014). 477 Commission Implementing Decision (EU) 2017/2320 on the equivalence of the legal and supervisory framework of

the United States of America for national securities exchanges and alternative trading systems in accordance with Di-

rective 2014/65/EU of the European Parliament and of the Council (Dec. 13, 2017). 478 Commission Implementing Decision (EU) 2017/2319 on the equivalence of the legal and supervisory framework

applicable to recognised exchange companies in Hong Kong Special Administrative Region in accordance with Directive

2014/65/EU of the European Parliament and of the Council (Dec. 13, 2017). 479 Commission Implementing Decision (EU) 2017/2441 on the equivalence of the legal and supervisory framework

applicable to stock exchanges in Switzerland in accordance with Directive 2014/65/EU of the European Parliament and

of the Council (Dec. 21, 2017).


processes in place, to verify that their order execution process is consistent with their best execu-

tion obligation. If any deficiencies are detected, they are required to take all appropriate remedial

actions to ensure that they are taking ‘all sufficient steps’ to achieve the best possible results for

their clients.480

When executing client orders, investment firms are to take into account a number of factors (char-

acterization of the client, characteristics of the order, of the financial instrument, of the execution

venue).481 Where an investment firm executes an order on behalf of a retail client, the best possi-

ble result is determined in terms of the total consideration (representing the price and the costs

relating to execution).482 Investment firms cannot receive any remuneration, discount or non-

monetary benefit for routing client orders to a particular trading or execution venue, as also ad-

dressed in the payment for order flow section of the report.483

When it comes to investment firms that do not directly execute on an execution venue, but rather

place or transmit client orders for onward execution, they are also subject to the ‘best execution’

obligation. They need to provide disclosures in relation to the entities or intermediaries to which

they pass an order in the chain of execution.484

Reports and recording

The detailed reporting rules are set out in RTS 27 (data to be published by execution venues) and

RTS 28485 (information to be published by investment firms, on the identity of execution venues

and on the quality of execution). These reports are different from the transaction reporting and

trade reporting discussed in the previous section of this report. RTS 27 and 28 reports are meant

to provide clients with an ongoing view of the execution they are receiving in the marketplace.486

RTS 27 requires that execution venues487 make available to the public, without any charges, de-

tailed data relating to the quality of execution of transactions on that venue.488 The RTS 27 report-

ing requirements cover all transactions in financial instruments, including those that are subject

480 ESMA, Q & A, ‘On MiFID II and MiFIR investor protection and intermediaries topics’, (28 March 2019), Section 1,

Answer 1. 481 Commission Delegated Regulation 2017/565, Article 64. 482MiFID 2 Directive, Article 27(1). 483 Article 27(2), discussed further under ‘payments for order flow’ below. 484 Commission Delegated Regulation 2017/565, Article 65. 485 Commission Delegated Regulation (EU) 2017/576 of 8 June 2016 supplementing Directive 2014/65/EU of the Euro-

pean Parliament and of the Council with regard to regulatory technical standards for the annual publication by invest-

ment firms of information on the identity of execution venues and on the quality of execution (‘RTS 28’). 486 Mason, ‘MiFID 2 best execution: Are firms ready for RTS27 and 28?’ (April 10, 2018), https://www.refinitiv.com/per-

spectives/regulation-risk-compliance/mifid-ii-best-execution-are-firms-ready-for-rts-27-and-28/ 487 Under Article 23 of MiFIR, discussed above. Trading venues and SI are obliged to produce reports in relation to

shares subject to the ‘share trading obligation’ (which is set out in MiFIR, Article 23(1) and requires that shares admitted

to trading on an RM be traded either on a trading venue or SI in the EU or a third country equivalent) while each

execution venue is obliged to produce information in relation to shares not subject to the ‘share trading obligation’,

RTS 27, Recital 1. 488 RTS 27, Articles 3 - 8.

https://www.refinitiv.com/perspectives/regulation-risk-compliance/mifid-ii-best-execution-are-firms-ready-for-rts-27-and-28/

https://www.refinitiv.com/perspectives/regulation-risk-compliance/mifid-ii-best-execution-are-firms-ready-for-rts-27-and-28/


to the pre-trade transparency waivers.489 The data is to include the details of the price, costs, speed

and likelihood of execution for individual financial instruments490 and is to be published quarterly,

no later than three months after the end of each quarter.491

RTS 28 reports summarize execution quality achieved by investment firms. RTS 28 specifies both

the format and the content of the information to be published492 by investment firms on an annual

basis in relation to client orders executed on trading venues, SIs, market makers or other liquidity

providers or entities that perform a similar function in a third country.493 The reports are to be

made public on or before the 30th of April following the end of the period to which the report

relates,494 and are to remain available in the public domain for a minimum period of two years.495

In terms of their content, the RTS 28 reports by investment firms are to identify the top five

execution venues or firms (brokers where they have sent client orders), in terms of trading vol-

umes for all executed client orders per class of financial instrument (in different formats for retail

and for professional clients ). The reports should include a list of qualitative and quantitative

factors used to select the execution venues. They are also to provide a summary of the analysis

and conclusions the investments firms draw from their detailed monitoring of the quality of exe-

cution they obtained on the execution venues they used, again in relation to each class of fi-

nancial instrument. The reports are to include matters such as how the price, costs, speed and

likelihood of execution are factored in the overall assessment of execution quality achieved;

whether there are close connections to venues, conflicts of interest or shared ownership of venues

has influenced execution quality; whether (non-) monetary benefits have been received; whether

489 RTS 27, Recital 6. ESMA, Q & A, ‘On MiFID II and MiFIR investor protection and intermediaries topics’, 28 March 2019,

Section 1, Answer 20. 490 RTS 27, Articles 2 - 10. 491 MiFID 2 Directive, Article 27(3); RTS 27, Article 11. 492 This can be on a website, but reports are not to be placed behind a firewall, registration page or be subject to

password encryption or other restrictions, ESMA, Q & A, ‘On MiFID II and MiFIR investor protection and intermediaries

topics’, (28 March 2019), Section 1, Answer 8. 493 RTS 28, Article 1. 494 ESMA, Q & A, ‘On MiFID II and MiFIR investor protection and intermediaries topics’, (28 March 2019), Section 1,

Answer 5,. 495 ESMA, Q & A, ‘On MiFID II and MiFIR investor protection and intermediaries topics’, (28 March 2019), Section 1,

Answer 4. 496 The investor protection rules in Europe are two-tiered between retail and professional investors, and client catego-

rization is binding, World Bank Working Paper No. 184, p. vii. 497 RTS 28, Article 3. 498 RTS 28, Article 3. ESMA, Q & A, ‘On MiFID II and MiFIR investor protection and intermediaries topics’, (28 March

2019), Section 1, Answer 3 sets out further details of what information might be helpful in this exercise, especially where

single venue is used. 499 RTS 28, Article 3(3). 500 ESMA, Q & A, ‘On MiFID II and MiFIR investor protection and intermediaries topics’, (28 March 2019), Section 1,

Answer 10.


any changes occurred regarding the execution venues listed in the best execution policy, and

whether execution quality differs if confronted with retail or professional clients.

When firms provide both order execution and the transmission of orders to a third party for exe-

cution, they need to provide two separate reports in relation to those services. Specifically, they

must provide (1) the top five execution venues at which they execute orders and (2) the top five

entities (brokers) to which they routed client orders in the relevant period.502

As far as record keeping is concerned, MiFID 2 imposes the following record keeping and docu-

mentation obligations on investment firms:503 (1) the requirement to record all services, activities

and transactions;504 and (2) the requirement to provide clients with reports on all services pro-

vided.505

Payment for order flow

Payment for order flow (“PFOF”) occurs when an investment firm that routes client orders receives

a fee from the counterparty with which the trade is then executed (typically a market maker or

other liquidity provider). Under MiFID 2, these payments are viewed as creating a conflict of

interest between the investment firm and its client, by incentivizing the firm to route its client

orders to counterparties willing to pay the highest fee.

Specifically, Article 27(2) of the MiFID 2 Directive states: ‘An investment firm shall not receive any

remuneration, discount or non-monetary benefit for routing client orders to a particular trading

venue or execution venue, which would infringe the requirements on conflicts of interest or in-

ducements…’. The EU rules on conflict of interest or inducements are such that Article 27 has

been construed as prohibiting payments for order flow in the EU. However, because the prohi-

bition must be implemented by respective member states, there is potential for regulatory diver-

gence.

501 PWC, ‘MiFID II Hot Topic: Best Execution’ (June 2017), available at https://www.pwc.com/gx/en/financial-ser-

vices/pdf/best-execution-hot-topic.pdf 502 ESMA, Q & A, ‘On MiFID II and MiFIR investor protection and intermediaries topics’, (28 March 2019), Section 1,

Answer 7. 503 This is in addition to the obligation to record certain face-to-face conversations, see ESMA, Q & A, ‘On MiFID II and

MiFIR investor protection and intermediaries topics’, (28 March 2019), Section 2, Answer 8. 504 MiFID 2 Directive, Article 16(6); Commission Delegated Regulation 2017/565, Article 74. 505 MiFID 2 Directive, Article 25(6); Commission Delegated Regulation 2017/565, Articles 59 – 63, 66 (execution policy);

suitability reports are to be provided whether or not the investment advice given leads to a transaction, see ESMA, Q &

A, ‘On MiFID II and MiFIR investor protection and intermediaries topics’, (28 March 2019), Section 2, Answer 1. On

requirement for disclosure of costs, see in particular Article 24 of the MIFID 2 Directive, Article 50(9) of the Commission

Delegated Regulation 2017/565 and ESMA, Q & A, ‘On MiFID II and MiFIR investor protection and intermediaries topics’,

(28 March 2019), Section 9. 506 FCA Market Watch, Newsletter on market conduct and transaction reporting issues, September 2018, p. 3 507 Those are set out in particular in Art 27(1) (the best execution rule), Art 16(3) (organizational and administrative

arrangements for avoiding conflicts of interest), Art 23 and 24 (investor protection). 508 See, for example, Ball, ‘Expert Claims Payment for Order Flow Loophole in MiFID II’, in FinReg Alert (May 9, 2018) at

http://www.finregalert.com/expert-claims-payment-for-order-flow-loophole-in-mifid-ii/

http://www.finregalert.com/expert-claims-payment-for-order-flow-loophole-in-mifid-ii/


Maker/taker arrangements

However, trading venues, can provide market makers with incentives to provide liquidity to the

trading venue. MiFID 2 provides that trading venues need to have written agreements in place

with any investment firms pursuing a market making strategy on their market, including details of

any incentives in terms of rebates, or otherwise offered by them to the investment firm in return

for providing liquidity on a regular and predictable basis, or any other rights accruing to such a

firm. Trading venues are obliged to inform their national competent authority about the content

of those agreements.

ESMA has clarified that ‘rebates’ in this context includes negative fees, direct payments, refunds

or discounts on fees due from the provider of liquidity to the trading venue. ‘Maker/taker ar-

rangements’, in which financial incentives are provided to market participants to conclude trades

by posting passive orders, are permitted both in relation to investment firms required to enter

into market making arrangements, and in relation to other market makers provided they are sub-

ject to the appropriate market making obligations. Article 17(4) requires that investment firms

engaged in algorithmic trading enter into a market making arrangement when they: deal on their

own account, post firm simultaneous two-way quotes of comparable size and at comparative

prices relating to one or more financial instruments on a single trading venue or across different

trading venues, with the result of providing liquidity on a regular and frequent basis to the overall

market.

MiFID 2 requires a share’s minimum tick size to be calibrated in terms of liquidity measured by

the average daily number of transactions515 executed on the most relevant market.516 The regime

applies equally, regardless of the currency of the financial instrument, as it determines only the

minimum difference between the two price levels of orders sent in relation to a financial instru-

ment in the order book.517

509 MiFID 2 Directive, Article 4(1)(7). 510 RTS 8, Recital 5 suggests that, with algorithmic trading, incentives under a market making scheme should only be

required for certain instruments traded under a continuous order book trading system. 511 MiFID 2 Directive, Article 48(3) (which covers regulated markets) and Article 18(5) (which requires investment firms

and market operators of MTFs and OTFs to comply with Article 48). This may include a firm engaging in algorithmic

trading, that is pursuing a market making strategy under MiFID 2 Directive, Article 17(4). 512 MiFID 2 Directive, Article 48(3). For the templates to be used to notify ‘incentive schemes’ and provide copies of

market making agreements in the UK, see FCA, ‘Trading Venue Notifications’, https://www.fca.org.uk/publication/doc-

uments/trading-venue-notifications-mifid-ii.pdf 513 ESMA, Q & A, ‘On MiFID and MiFIR market structure topics’ (1 February 2019), Section 5, Answer 9. 514 ESMA, Q & A, ‘On MiFID and MiFIR market structure topics’ (1 February 2019), Section 5, Answer 9. 515 MiFID 2 Directive, Article 49 and Commission Delegated Regulation (EU) 2017/588 of 14 July 2016 supplementing

Directive 2014/65/EU of the European Parliament and of the Council with regard to regulatory technical standards on

the tick size regime for shares, depositary receipts, and exchange-traded funds (‘RTS 11’).RTS 11, Articles 2 and 3,

Annex. 516 RTS 11, Article 1. The most relevant market in terms of liquidity is determined in accordance with RTS 1, Article 4. 517 RTS 11, Recital 8.

https://www.fca.org.uk/publication/documents/trading-venue-notifications-mifid-ii.pdf

https://www.fca.org.uk/publication/documents/trading-venue-notifications-mifid-ii.pdf


The requirement applies to both orders and quotes.518 Originally, SIs did not need to comply with

the tick size regime, 519 but the regulatory standards were modified to extend the tick size regime

to SIs for trades at or below standard market size.520

The table on the following page specifies the minimum tick size regime that applies to instruments

depending on their liquidity and price level.

Liquidity bands (average number of daily transactions)

0 ≤ t < 10 10 ≤ t

< 80

80 ≤ t

< 600

600 ≤ t < 2,000 2000 ≤ t < 9,000 9,000 ≤

t

Pri

ce r

an

ges

< 0.1 0.0005 0.0002 0.0001 0.0001 0.0001 0.0001

0.1 ≤ p < 0.2 0.001 0.0005 0.0002 0.0001 0.0001 0.0001

0.2 ≤ p < 0.5 0.002 0.001 0.0005 0.0002 0.0001 0.0001

0.5 ≤ p < 1 0.005 0.002 0.001 0.0005 0.0002 0.0001

1 ≤ p < 2 0.01 0.005 0.002 0.001 0.0005 0.0002

2 ≤ p < 5 0.02 0.01 0.005 0.002 0.001 0.0005

5 ≤ p < 10 0.05 0.02 0.01 0.005 0.002 0.001

10 ≤ p < 20 0.1 0.05 0.02 0.01 0.005 0.002

20 ≤ p < 50 0.2 0.1 0.05 0.02 0.01 0.005

50 ≤ p < 100 0.5 0.2 0.1 0.05 0.02 0.01

100 ≤ p < 200 1 0.5 0.2 0.1 0.05 0.02

200 ≤ p < 500 2 1 0.5 0.2 0.1 0.05

500 ≤ p < 1,000 5 2 1 0.5 0.2 0.1

1,000 ≤ p < 2,000 10 5 2 1 0.5 0.2

2,000 ≤ p < 5,000 20 10 5 2 1 0.5

5,000 ≤ p < 10,000 50 20 10 5 2 1

10,000 ≤ p < 20,000 100 50 20 10 5 2

20,000 ≤ p < 50,000 200 100 50 20 10 5

50,000 ≤ p 500 200 100 50 20 10

MiFID 2 defines “algorithmic trading” as trading in financial instruments where a computer al-

gorithm automatically determines individual parameters of orders such as whether to initiate the

order, the timing, price or quantity of the order or how to manage the order after its submission,

with limited or no human intervention.521

518 ESMA, Q & A, ‘On MiFID and MiFIR market structure topics’ (1 February 2019), Section 4, Answer 10. 519 See ESMA, Opinion – Amendments to Commission Delegated Regulation (EU) 2017/587 (RTS 1),

https://www.esma.europa.eu/sites/default/files/library/esma70-156-354_final_report_rts_1_amendment.pdf. 520 Commission Delegated Regulation (EU) 2019/442 of 12 December 2018 amending and correcting Delegated Regu-

lation (EU) 2017/587 to specify the requirement for prices to reflect prevailing market conditions and to update and

correct certain provisions. 521 MiFID 2 Directive Article 4(1) (39).


MiFID 2 imposes organizational requirements on investment firms engaged in algorithmic trad-

ing,522 including requirements to put in place systems and risk controls of algorithms and keep

sequenced records with respect to its trading activity.523 Firms must have both pre and post trade

controls to monitor, identify and reduce trading risks across algorithmic trading activity.524 The

aim of these requirements is to ensure the resilience of trading systems,525 to avoid the transmis-

sion of erroneous orders526 and to provide supervisors with information on the activities of algo-

rithmic trading.527 Algorithmic traders that use market making strategies must enter into market

making agreements with trading venues on which they operate, to ensure that they provide li-

quidity on a regular and predictable basis.528

An investment firm engaging in algorithmic trading or providing direct electronic access must

notify its Member State competent authority and the Member State competent authority of any

trading venue of which it is a member.529 Its competent authority may require it to provide, on a

regular or ad-hoc basis, (a) a description of the nature of its strategies, (b) details of the trading

parameters or limits to which the system is subject, (c) a description of the key compliance and

risk controls that it has in place and (d) information about the testing of its systems.530 The com-

petent authority of the investment firm’s home jurisdiction is also required to communicate that

information to the competent authority of the trading venue upon request.531

Trading venues enabling or allowing algorithmic trading through their systems are also subject to

various obligations, including certain organizational requirements,532 and requirements affecting

capacity and resilience.533 Trading venues are required to provide testing platforms to ensure that

algorithms can deal with stressed market conditions.534 Trading venues must also have in place

certain pre-trade controls adopted for each instrument traded on them (price collars, maximum

order value and maximum order volume) and can have such post-trade controls as they deem

appropriate on the basis of their risk assessment.535 Trading venues must set limits on the number

522 For detail, see Commission Delegated Regulation (EU) 2017/589 of 19 July 2016 supplementing Directive 2014/65/EU

of the European Parliament and of the Council with regard to regulatory technical standards specifying the organiza-

tional requirements of investment firms engaged in algorithmic trading (‘RTS 6’). 523MiFID 2 Directive, Article 17. 524 RTS 6, Articles 15 and 17. For the review of the application of those requirements in the UK, see FCA, ‘Algorithmic

Trading Compliance in Wholesale Markets’ (February 2018), section 4. 525 For further specification of ‘resilience of trading systems’, see RTS 6, Chapter II. 526 See for example RTS 6, Article 15. 527 FINANCIAL CONDUCT AUTHORITY, Algorithmic Trading Compliance in Wholesale Markets, 5 (Feb. 2018)

https://www.fca.org.uk/publication/multi-firm-reviews/algorithmic-trading-compliance-wholesale-markets.pdf. 528 MiFID 2 Directive, Article 17(3). 529 MiFID 2 Directive, Article 17(2). 530 Id. 531 Id. 532 Commission Delegated Regulation (EU) 2017/584 of 14 July 2016 supplementing Directive 2014/65/EU of the Euro-

pean Parliament and of the Council with regard to regulatory technical standards specifying organizational require-

ments of trading venues (“RTS 7”), Chapter I. 533 RTS 7, Chapter II. 534 Article 48(6). 535 RTS 7, Article 20.

https://www.fca.org.uk/publication/multi-firm-reviews/algorithmic-trading-compliance-wholesale-markets.pdf


of order messages that a market participant can send relative to the number of transactions they

undertake (the participant’s order-to-trade-ratio, or “OTR”).536 In addition, to enable retrospective

reconstruction of trading activity by regulators, investment firms and trading venues must syn-

chronize their clocks.537

MiFID 2 defines “high frequency trading” or “HFT”538 as a subset of algorithmic trading charac-

terized by: (a) infrastructure intended to minimize network and other types of latencies, including

at least one of the these facilities for algorithmic order entry: co-location, proximity hosting or

high-speed direct electronic access; (b) system-determination of order initiation, generation,

routing or execution without human intervention for individual trades or orders; and (c) high

intraday message rates which constitute orders, quotes or cancellations.539

HFT firms are subject to the obligations imposed on algorithmic trading firms generally and also

must comply with further obligations. For example, HFT firms must store time-sequenced records

of their algorithmic trading systems and trading algorithms540 for at least five years.541 Trading

activity must be time-stamped with 100-microsecond accuracy.542 Further, ESMA has taken the

position that high frequency traders should ‘immediately’ seek authorization as investment

firms.543

A salient characteristic of certain HFT strategies, including the market making and arbitrage activ-

ities described in Section 1f, is the submission, revision and or cancellation of a large number of

orders within a short time period. The high number of order messages has given rise to concerns

about the ability of IT systems at trading venues to handle these significant volumes. As noted

536 Commission Delegated Regulation (EU) 2017/566 of 18 May 2016 supplementing Directive 2014/65/EU of the Euro-

pean Parliament and of the Council on markets in financial instruments with regard to regulatory technical standards

for the ratio of unexecuted orders to transactions in order to prevent disorderly trading conditions (“RTS 9”) provides

the detail of the calculations to be done. 537 MiFID 2 Directive, Article 50. 538 MiFID 2 expressly recognizes the benefit of HFT – including wider participation in markets, increased liquidity, nar-

rower spreads, reduced short-term volatility and better execution for client orders—but also identifies concerns such

as the potentially increased risk of market disruption. See MiFID 2 Directive, Recital 62. 539 MiFID 2 Directive, Article 4(1) (40). The concept of “high message intraday rates” was further clarified to mean: (1) at

least two messages per second with respect to any single financial instrument traded on a trading venue; (2) at least

four messages per second with respect to all financial instruments traded on a trading venue. The calculations include

messages concerning financial instruments for which there is a liquid market, messages introduced for the purpose of

market-making, and messages introduced for the purpose of proprietary dealing. Commission Delegated Regulation

(EU) 2017/565, Article 19(1)-(3). 540 MiFID 2 Directive, Article 17. 541 RTS 6, Article 28. 542 MiFID 2 Directive, Article 17(2). See also EUROPEAN SECURITIES AND MARKET AUTHORITY, Regulatory technical and imple-

menting standards – Annex I – MiFID II / MiFIR, ESMA/2015/1464, 222-23 (September 28, 2015). 543 EUROPEAN SECURITIES AND MARKET AUTHORITY, Questions and Answers: On MiFID II and MiFIR market structures, Question

5 (Feb. 1, 2019) https://www.esma.europa.eu/sites/default/files/library/esma70-872942901-38_qas_markets_struc-

tures_issues.pdf. (‘Where a firm engages in [high-frequency trading] and is not authorised as an investment firm under

MiFID II, the firm is required to immediately seek authorisation as required under Article 2(1)(d)(iii) of MiFID II. ESMA

reminds that any firm engaged in algorithmic trading (including HFT) has to notify this circumstance to the national

competent authority of its home Member State and to the national competent authorities of the trading venues at

which it engages in algorithmic trading as member or participant.’). See also MiFID 2 Directive, Recital 63.

https://www.esma.europa.eu/sites/default/files/library/esma70-872942901-38_qas_markets_structures_issues.pdf

https://www.esma.europa.eu/sites/default/files/library/esma70-872942901-38_qas_markets_structures_issues.pdf


earlier, MiFID 2 mandates that trading venues set limits on market participants’ OTR; MiFID 2 also

allows, but does not require, OTR fees.544 Several European jurisdictions had already introduced

OTR fees prior to MiFID 2. Italy was among the first jurisdictions to assess an OTR fee: Borsa

Italiana, Italy’s main stock exchange, charges a fee-per-order that increases on a sliding scale

based on a trader’s OTR.545 France implemented OTR fees as part of a legislative package that also

included a financial transactions tax on certain stock transactions. A fee equal to 0.01% of the

notional amount of modified or cancelled orders is imposed on financial intermediaries estab-

lished in France whose OTR exceeds five.546 Notably, the OTR fee is directed only at HFT activities

that are thought to be potentially harmful. Accordingly, activities pertaining to market making,

smart order routing, and automated execution of large orders are exempt from the fee.547 Norway

has also introduced OTR fees on the Oslo Stock Exchange; a fee of 0.05 Norwegian krone (NOK)

per order is levied on traders with OTR higher than 70 to 1. The ratio is calculated on a monthly

basis, and like the French OTR fee, is targeted only at activities that are perceived to be detrimental

to market quality: orders that stay in the market for longer than a second, or that improve price

or volume are not counted towards the OTR.548

The separate Market Abuse Regulation (MAR) targets market manipulation.549 Though the MAR is

targeted at market manipulation rather than algorithmic trading, it includes provisions that spe-

cifically mention algorithmic trading and HFT: it explicitly prohibits sending orders, including by

means of algorithmic trading and HFT strategies, that would disrupt or delay the functioning of

544 MiFID 2 Directive, Articles 48(9) (regulated markets) and 18(5) (MTFs). 545 See Kee H. Chung and Albert Lee, High-frequency Trading: Review of the Literature and Regulatory Initiatives around

the World, 45 Asia-Pacific Journal of Financial Studies 7, 23 (March 18, 2016); BORSA ITALIANA, Pricelist for trading services,

24 (Sep. 2018). 546 See Chung and Lee, High-frequency Trading: Review of the Literature and Regulatory Initiatives around the World, 45

Asia-Pacific Journal of Financial Studies at 24. 547 See id. 548 See id; OSLO STOCK EXCHANGE, Oslo Børs to discourage excessive order activity (May 24, 2012), available at

https://www.oslobors.no/ob_eng/Oslo-Boers/About-Oslo-Boers/News-from-Oslo-Boers/Oslo-Boers-to-discourage-

excessive-order-activity. Regulators in other jurisctions have taken similar steps aimed at the submission of numerous,

ultimately unexecuted orders. In 2012, the Investment Industry Regulatory Organization of Canada (IIROC, the Canadian

regulator that oversees investment dealers and trading activities, changed the way it allocates fees (the overall amount

of fees is determined on a cost recovery basis) between venues (which then pass fees on to broker-dealers, who in turn

recover those fees through commissions or by charging clients on a message- or trade-basis). Before April 2012, IIROC’s

fees were allocated based on market share of trading volume; they were subsequently changed so that they are allo-

cated in part based on the market share of messages (where a message includes a trade, order submission, cancellation

or modification). See Katya Malinova, Andreas Park and Ryan Riordan, Do retail traders suffer from high frequency trad-

ers? (October 3, 2013), available at http://qed.econ.queensu.ca/pub/faculty/milne/322/IIROC_FeeChange_submis-

sion_KM_AP3.pdf. 549 The MAR replaces the 2003 Market Abuse Directive, which was considered to have too many loopholes. Article

12(1)(a) and (b) distinguish between open market manipulation (facially legitimate orders or transactions that are only

intended to influence price) and the use of fictitious devices or contrivances (using out-of-market actions, such as

disseminating false information, to influence prices). Article 12(2) includes a list of prohibited manipulative behaviors;

Annex I gives a list of indicators of manipulative behavior (see also Commission Delegated Regulation 2016/422, which

includes a longer list).

https://www.oslobors.no/ob_eng/Oslo-Boers/About-Oslo-Boers/News-from-Oslo-Boers/Oslo-Boers-to-discourage-excessive-order-activity

https://www.oslobors.no/ob_eng/Oslo-Boers/About-Oslo-Boers/News-from-Oslo-Boers/Oslo-Boers-to-discourage-excessive-order-activity

http://qed.econ.queensu.ca/pub/faculty/milne/322/IIROC_FeeChange_submission_KM_AP3.pdf

http://qed.econ.queensu.ca/pub/faculty/milne/322/IIROC_FeeChange_submission_KM_AP3.pdf


trading venues’ servers, make it difficult to identify genuine orders, or create or likely create mis-

leading signals about the supply and demand of a financial product.550 Indicators of manipulative

orders include the extent to which (1) trader’s orders represent a significant proportion of trading

activity, (2) orders are concentrated in a short time-span, and (3) orders change the order book,

as well as (4) position reversals and (5) whether orders are sent at a specific time in the trading

session. Investment firms or trading venues that detect suspicious trading activity are required to

report to their regulator.551

In the EU, the primary volatility controls include measures on the provision of continuing liquid-

ity,552 on circuit breakers and trading halts,553 and on trading venue capacity generally.554

MiFID 2 requires trading venues to seek to ensure that they have in place a sufficient number of

market-making agreements with investment firms to achieve liquidity, appropriate for the nature

and the scale of their trading.555 Trading venues must also communicate the existence of stressed

market conditions to all market makers.556 Exceptional circumstances, when the obligation to pro-

vide liquidity does not apply, are to be defined exhaustively.557

Further, trading venues are to have in place effective systems, procedures and arrangements to

ensure that their trading systems have sufficient capacity to deal with peak order and message

volumes, are able to ensure orderly trading under conditions of severe market stress, are fully

tested to ensure such conditions are met, and are subject to effective business continuity arrange-

ments to ensure continuity of their services if there is any failure of their trading systems.558 They

should have effective systems, procedures and arrangements to reject orders that exceed pre-

determined volume and price thresholds or are clearly erroneous.559

Trading venue obligations include the need to have mechanisms in place to temporarily halt or

constrain trading if there is a significant price movement in a financial instrument on that trading

venue or a related trading venue during a short period and, in exceptional cases, to be able to

cancel, vary or correct any transaction560 (a circuit breaker). The trading venue with the highest

550 MAR Article 12(2)(c). 551 MAR Article 16(3). 552 MiFID 2 Directive, Article 48(2). Commission Delegated Regulation (EU) 2017/578 of 13 June 2016 supplementing

Directive 2014/65/EU of the European Parliament and of the Council on markets in financial instruments with regard to

regulatory technical standards specifying the requirements on market making agreements and schemes (‘RTS 8’). 553 MiFID 2 Directive, Article 48(5). 554 RTS 7, Art 11 555 MiFID 2 Directive, Article 48(2). RTS 8. 556 RTS 8, Article 4. 557 RTS 8, Recital 8, Article 3. 558 MiFID 2 Directive, Articles 48(1) and 18(5). Article 48 covers regulated exchanges; Article 18(5) provides for invest-

ment firms and market operators operating an MTF or OTF to comply with Article 48. RTS 7 deals with volatility ar-

rangements in relation to algorithmic trading. 559 MiFID 2 Directive, Article 48(4). 560 MiFID 2 Directive, Recital 64, Article 48(5). Trading halts include mechanisms to interrupt continuous trading. This

may consist of (i) stopping trading in relation to a financial instrument for a certain period of time, with no trades being


turnover561 in a financial instrument in the EU562 has to have necessary systems and procedures in

place to notify its competent authority that its circuit breaker has been triggered and its trading

halts applied, so that a market-wide response could be put in place, if appropriate.

ESMA has issued guidelines on the calibration of circuit breakers and publication of trading halts

under MiFID 2.563 The calibration is to be done according to a pre-defined, statistically supported

methodology, taking into account factors such as the nature of the financial instrument, the li-

quidity profile and the quotation level of the financial instrument, the volatility profile of the fi-

nancial instrument, the order imbalance (when manual re-calibration may be required), and static

and dynamic reference prices (unless the trading venue can demonstrate that only one of those

categories is sufficient).564

MiFID 2 requires investment firms engaged in algorithmic trading to have emergency “kill func-

tionality,” allowing them to cancel all of their unexecuted orders with immediate effect, where

that becomes necessary.565

Trading venues must have systems and procedures in place to ensure that algorithmic trading

cannot create or contribute to disorderly trading conditions. This includes an obligation to calcu-

late the ratio of unexecuted orders to transactions effectively incurred by their members or par-

ticipants at the level of each financial instrument traded on them, in order to ensure effectively

that the ratio does not lead to excessive volatility in that instrument.566

executed in that instrument and no new prices being determined, or (ii) switching trading from continuous trading to a

call auction. Definition of trading halts used in ESMA Guidelines ‘Calibration of circuit breakers and publication of trad-

ing halts under MiFID II’ (06/04/2017) 561 Turnovers are calculated, in accordance with certain specified parameters, by the national regulators, RTS 1, Article

4 (2) and (3). 562 RTS 9, Recital 4, Article 1; RTS 1, Article 4. 563 ESMA Guidelines ‘Calibration of circuit breakers and publication of trading halts under MiFID II’ (06/04/2017). 564 ESMA Guidelines, para 5.1 565 RTS 6, Recital 9 and Article 12. For further detail see FCA, ‘Algorithmic Trading Compliance in Wholesale Markets’,

cited above. 566 RTS 9, Recital 1 and 4, Article 2.


The main laws applicable to securities markets in Japan are the Financial Instruments Exchange

Act (“FIEA”) and the Investment Trust and Investment Corporations Act (“ITIC”).567 The FIEA as-

signs primary responsibility for the regulation and supervision of securities markets to the Prime

Minister.568

In practice, the regulation and supervision of securities markets is primarily delegated to the Fi-

nancial Services Agency (“FSA”) and the Securities Exchange and Surveillance Commission

(“SESC”). The FSA, which is a cabinet agency, is responsible for policy, off-site monitoring and

enforcement. The SESC—a board within the FSA that is afforded a high degree of independence

from the FSA under the FIEA—carries out onsite inspections and investigations of securities firms

(“financial instruments business operators”, or “FIBOs”).569

The FIEA authorizes the FSA and SESC to delegate certain monitoring and inspection functions to

local finance bureaus. From an operational perspective, the FSA and SESC entrust local finance

bureaus with the registration of FIBOs and the off-site monitoring and on-site inspections of

smaller FIBOs. In addition, the FIEA authorizes stock exchanges to exercise self-regulatory author-

ity or to delegate such authorities to separate self-regulatory organizations (“SROs”). Other enti-

ties, such as the Japan Securities Dealers Association (“JSDA”), are also authorized to perform

certain self-regulatory functions.570

Key definitions

Financial instruments

business

the performance of any of the following acts on a regular basis: (i) purchase

and sale of securities or market derivatives transaction; (ii) intermediation,

brokerage or agency for the purchase and sale of securities or market de-

rivatives transactions; (iii) over-the-counter transactions of derivatives or

intermediation, brokerage or agency for it; (iv) brokerage for clearing of

securities; (v) securities underwriting; (vi) public offering or private place-

ment of securities; (vii) secondary distribution of securities; (viii) dealing in

public offering or secondary distribution of securities, or dealing in private

placement of securities; (iv) purchase and sale of securities or intermedia-

tion, brokerage, or agency for it, using an electronic data processing sys-

567 See International Monetary Fund, Monetary and Capital Markets Department (IMF), Japan: IOSCO Objectives and

Principles of Securities Regulation— Detailed Assessment of Implementation, IMF Country Report No. 12/230, 7 (August

2012). 568 See id at 6. 569 See id. 570 See id.


tem; (x) provision of investment advisory services; (xi) provision of invest-

ment management services; or (xii) acts specified by regulation as being

equivalent to the foregoing.571


business operator or

FIBO

a person registered to conduct a financial instruments business.572


market

a market on which the purchase and sale of securities or market derivatives

transactions are conducted (excluding a market in which only commodity-

related market derivatives transactions are conducted).573


exchange

a financial instruments membership corporation or stock company that is

licensed to operate a financial instruments market.574

High-speed trading

activity or HFT

(1) any activity that is either:

(a) the purchase or sale of securities or market transactions of deriva-

tives (“Activity (a)”);

(b) engaging a third party for Activity (a);

(c) managing cash or other assets by way of Activity (a) (including giv-

ing an instruction); or

(d) carrying out a transaction or other conduct that results in its coun-

terparty conducting in Activity (a), such as conducting market

transactions of derivatives with a party conducting in Activity (a) as

the counterparty; where

(2) the decision to conduct such activity set forth in (1) above is made

automatically by an electronic data processing system; and

(3) the transmission of information necessary to carry out, based on such

decision, the corresponding purchase or sale of securities or market

transactions of derivatives to a financial instrument exchange or a pro-

prietary trading system is done in a manner that utilizes information

communication technology and shortens the time usually required for

such communication to be transmitted and (a) the facility in which the

electronic data processing system used for decision making is located

within (or adjacent or in proximity to) the location in which the respec-

tive exchange or proprietary trading system has installed its electronic

data processing system to receive such transmission of the infor-

mation, and (b) a mechanism has been put in place to prevent the

transmission of information hereunder from competing with other

transmissions to carry out the purchase or sale of securities or market

571 See FIEA, Article 2(8). 572 See FIEA, Article 2(9). 573 See FIEA, Article 2(14). 574 See FIEA, Article 2(16).


transactions of derivatives to such exchange or proprietary trading sys-

tem.575

Proprietary trading

system or PTS

a market on which sales and purchase of securities is conducted through

an electronic data processing system, by using any of the following price

formation method or other similar method, and in which a large number

of persons participate simultaneously as the one party in the transaction

or the transaction is conducted between a large number of persons: (a) an

auction method; (b) with respect to listed securities, a method using the

trading price of securities on a financial instruments market; (c) with re-

spect to over-the-counter securities, a method using the trading price of

securities published by the authorized financial instruments firms associa-

tion with which the securities are registered; (d) a method using the price

decided by negotiation between customers; and (e) methods specified by

regulation.576

Trading participant a person who is allowed to participate in the sales and purchase of securi-

ties or market transactions of derivatives in financial instruments exchange

market based on the relevant qualifications for trading.577

Type I Financial In-

struments Business

the performance of one of the following activities on a regular basis: (i) the

purchase and sale of securities; (ii) intermediation, brokerage or agency for

the purchase and sale of securities or commodity-related market deriva-

tives transactions; (iii) over-the-counter transactions of derivatives or in-

termediation, brokerage or agency for it; (iv) brokerage for clearing of se-

curities, commodity-related market derivatives transactions or over-the-

counter transactions of derivatives; (v) secondary distribution of securities;

(vi) dealing in public offering or secondary distribution of securities, or

dealing in private placement of securities; (vii) securities underwriting; or

(viii) purchase and sale of securities or intermediation, brokerage, or

agency for it, using an electronic data processing system.578

Type II Financial In-

struments Business

the performance of one of the following activities on a regular basis: (i) the

public offering or private placement of certain specified liquid securities;

(ii) purchase and sale of illiquid securities; (ii) intermediation, brokerage or

agency for the purchase and sale of illiquid securities; (iii) brokerage for

clearing of illiquid securities; (iv) underwriting of illiquid securities; (v) pub-

lic offering or private placement of illiquid securities; (vi) secondary distri-

bution of illiquid securities; or (vii) dealing in public offering or secondary

distribution of illiquid securities, or dealing in private placement of illiquid

securities.579

575 See FIEA, Article 2(41); Order for Enforcement of the FIEA, Article 1(22)(i)-(ii); Cabinet Office Ordinance regarding

Definitions under Article 2 of the FIEA, Article 26(1)-(2). 576 See FIEA, Article 2(8)(x); Cabinet Office Ordinance on Financial Instruments Business, No. 52 of 2007, Article 4(ix). 577 See FIEA, Article 2(19). 578 See FIEA, Article 28(1). 579 See FIEA, Article 28(2).


There are four financial instruments markets (stock exchanges) in Japan: the Japan Exchange

Group (“JPX”), formed from the combination of the Tokyo and Osaka exchanges, and the Nagoya,

Sapporo, and Fukuoka exchanges.580 Japanese stock exchanges were historically membership or-

ganizations consisting of securities companies. However, under a 2000 amendment to the FIEA,

they were authorized to change their status to joint stock companies—the JPX (parent company

of the Tokyo Stock Exchange (“TSE”)) and the Nagoya Stock Exchange have already done so.581

The JPX is listed on the TSE.582

The vast majority of companies listed on Japan’s stock exchanges are on the TSE: as of April 2019,

there were 3,665 companies listed on the TSE, compared to 292 for the Nagoya Stock Exchange

(of which only 66 were listed exclusively), 109 for the Fukuoka Stock Exchange (26 exclusive list-

ings), and 57 for the Sapporo Securities Exchange (16 exclusive listings).583

In terms of equity market capitalization, the TSE is the third largest exchange in the world after

the U.S. New York Stock Exchange and NASDAQ. In terms of value of trading, the TSE ranks sixth.584

As of February 2019, the total market capitalization of the shares listed on the TSE was JPY 629

trillion and the value of shares traded on the TSE in that month was JPY 54 trillion.585

As of 2017, TSE has 93 trading participants, all of which are registered FIBOs.586 Japanese securities

firms include two major independent securities groups designated as Domestic Systemically Im-

portant Banks (D-SIBs) as well as the securities subsidiaries of the Japanese megabanks that are

G-SIBs. Foreign-owned FIBOs that are part of global G-SIB banking groups also have a significant

presence in Japan, accounting for more than half of the trading value at the TSE as of 2017.587 The

clients of FIBOs are primarily institutional investors, and institutional order flow accounts for be-

tween 70 to 80% of trading volume in the Japanese stock market as of 2015.588

580 See Japan Securities Research Institute (JSRI), Securities Market in Japan: 2016, 56 (2016), available at

http://www.jsri.or.jp/publish/english/pdf/english_08.pdf. 581 See id. 582 See OECD, OECD Equity Market Review: Asia 2018, OECD Capital Market Series, 36 (2018), available at

http://www.oecd.org/daf/ca/OECD-Equity-Market-Review-Asia-2018.pdf. 583 See Japan Exchange Group (JPX), Number of Listed Companies/Shares (Apr. 12, 2019), available at

https://www.jpx.co.jp/english/listing/co/index.html (TSE); Nagoya Stock Exchange, Listed Companies (Apr. 16, 2019),

available at http://www.nse.or.jp/e/meigara/stockcount/; Fukuoka Stock Exchange, About Us: Introduction,

https://www.fse.or.jp/english/about/index.php; Sapporo Securities Exchange, About Sapporo Securities Exchange (Janu-

ary 1, 2019), available at https://www.sse.or.jp/about. 584 International Monetary Fund, Monetary and Capital Markets Department (IMF), Financial Sector Assessment Program:

Technical Note – Regulation and Supervision of Securities Firms, IMF Country Report No. 17/284, 7 (September 2017). 585 See JPX, Monthly Statistics Report: Key Statistics for Domestic Stocks (February 2019), available at

https://www.jpx.co.jp/english/markets/statistics-equities/monthly/b5b4pj000002r67z-att/01_sokatu1902.pdf. 586 See id. 587 See IMF, Financial Sector Assessment Program: Technical Note at 4 (cited in note 10). 588 See Hideaki Kudoh and Kiminori Sano, Empirical Analysis of Transaction Costs in the Japanese Stock Market, Securities

Analysts Journal (August 2015), available at https://www.saa.or.jp/english/publications/kudoh_sano.pdf.


A 1998 amendment to the FIEA enabled competition between other trading venues and Japanese

stock exchanges by: (1) abolishing the “concentration rule” that required FIBOs to route orders

only to stock exchanges; (2) introducing a regulatory framework for “proprietary trading systems”

(“PTSs”) similar to the “alternative trading system” (in the United States) and “multilateral trading

facility” (in the European Union) frameworks; and (3) putting in place a set of rules for trading of

unlisted stocks.589

Alternative trading venues in Japan include regulated, “lit” PTS and unregulated, “dark” venues

(for both order matching and internalization) operated by FIBOs.590 In February 2019, approxi-

mately 9.8 percent of trading of listed stocks occurred off-exchange (including PTS and unregu-

lated dark venues), with approximately 60 percent of off-exchange trading (or 5.9 percent of all

trading) occurring on PTS.591

Stock Exchanges

Financial instruments exchanges operate financial instruments markets (stock exchanges), man-

aging and supervising the trading process and the business conduct of securities companies.592

The FIEA requires financial instruments markets to be licensed by the Minister of Financial Services

(“MoFS”) on behalf of the Prime Minister, based on the recommendation of the FSA, which reviews

applications for compliance with legal requirements.593 Financial instruments exchanges, which

operate financial instruments markets, must have capital of at least JPY1 billion.594

Financial instruments exchanges are overseen on an ongoing basis by the FSA and the SESC. Au-

thorization from the FSA is required for any material change to the articles of incorporation, op-

erational rules or brokerage contract rules.595 The FSA also must be notified if changes are to be

made to other rules, when securities or financial instruments are listed or when trading suspen-

sions are imposed or lifted.596

Financial instruments exchanges must ensure that securities and derivatives markets are fair and

protect investors by conducting regulatory, supervisory and disciplinary activities with respect to

589 See Working Group on Financial Markets, Agenda for competition among trading venues and alternative trading

platforms, Financial Markets Division, Financial Services Agency (Japan) (June 15, 2016), available at

https://www.fsa.go.jp/en/news/2016/20160513-1/03.pdf. 590 See IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 101-02 (cited in note 1). 591 See Japan Securities Dealers Association (JSDA), Monthly PTS Trading Volume of Shares Listed on Financial Instru-

ments Exchanges (March 22, 2019), available at http://www.jsda.or.jp/en/statistics/pts-for-equity/. See also Working

Group on Financial Markets, Agenda for competition among trading venues and alternative trading platforms (cited in

note 14) (as of 2016, approximately 90% of trading in listed stocks occurred on the TSE and 5% of trading occurred on

PTS). 592 See JSRI, Securities Market in Japan at 56 (cited in note 6). 593 See IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 7, 96 (cited in note 1). 594 See FIEA Article 83-2; Cabinet Order for Enforcement of FIEA Article 19. 595 See FIEA Article 149 596 See FIEA Articles 121, 128.


their members.597 Financial instruments exchanges can exercise self-regulatory authority them-

selves or delegate this authority to a separate SRO.598 For example, the TSE and Osaka Exchange

have delegated their self-regulatory services to Japan Exchange Regulation (“JPX-R”), a subsidiary

of JPX. The other exchanges (Nagoya, Fukuoka, and Sapporo) undertake their own self-regulatory

services.599 SROs must keep records and prepare reports as required by regulation.600

JPX-R determines disciplinary actions against trading participants for violations of laws and regu-

lations. Possible actions include fines, censure, trading suspension, and limiting or canceling trad-

ing qualifications. The disciplinary actions are determined after a hearing with the trading partic-

ipant and consultation with the disciplinary committee, which is an advisory body to the JPX-R

board. The TSE and Osaka Exchange take action based on the recommendations of JPX-R. The

disciplinary actions are published, and several actions have been taken over the past years.601

Access to exchanges

In order to trade on an exchange, a FIBO must first pass a qualification examination to be desig-

nated a trading participant.602 The operational rules of an exchange must contain detailed regu-

lations relating to trading participants.603 Financial instruments exchanges are prohibited from un-

just, discriminatory treatment of a member.604 Fairness of access is examined as part of the FSA’s

review of a financial instruments exchange’s license application and any amendment after licens-

ing is also reviewed for this purpose. Accordingly, before providing co-location facilities, both the

TSE and Osaka Exchange discussed fair access with the FSA.605

JPX-R, the SRO responsible for conducting regulatory, supervisory and disciplinary activities for

the TSE and Osaka Exchange, organizes qualification examinations for trading participants and

conducts inspections of them.606 The admission process for trading participants on the TSE re-

quires that the JPX-R conduct examinations based on documents, hearings, onsite inspections of

internal management systems at the applicant’s headquarters and branch offices, and interviews

with senior executives. The qualification criteria for the TSE include: (1) financial criteria (capital of

at least JPY 300 million, net assets of at least JPY 500 million and an amount greater than capital,

and capital adequacy ratio exceeding 200 percent); and (2) operational criteria (sound manage-

ment structure, order placement, execution, and clearing and settlement systems that contribute

597 See FIEA Article 80. 598 See FIEA Articles 102-14. 599 See IMF, Financial Sector Assessment Program: Technical Note at 15-16 (cited in note 10). 600 See FIEA Article 188; IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 42 (cited in note 1). 601 See id at 40. 602 See id at 16. 603 See FIEA Article 117. 604 See FIEA Articles 87-89. 605 See IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 98 (cited in note 1); IOSCO, Order Routing

Incentives: Final Report, FR08/2017, 9 (June 2017). 606 See IMF, Financial Sector Assessment Program: Technical Note at 16 (cited in note 10).


to fair and smooth trading, and appropriate internal management system (compliance with laws

and regulations, risk management, development of rules, etc.)).607

Only approved trading participants are connected to a financial instruments exchange’s trading

systems and may conduct sales and purchases of securities. However, sponsored client access is

permitted, so long as trading participants have appropriate order management systems for their

clients. In practice, trading participants establish order limits per client based on ratings and fi-

nancial standing. The robustness of such “filters” is reviewed ex-post via on-site inspections by

the JPX-R, financial instruments exchanges and/or the FSA.608

Trading fees

Financial instruments exchanges are required to obtain approval from the FSA for changes to their

fees or fee models.609 Exchanges are required to perform benchmarking analysis and/or impact

analysis, and the FSA must determine whether the structure of the model or the fee change is fair

or unduly discriminatory. The FSA evaluates the reasonableness of fee models and trading fees by

considering service provided vs. fees charged, operational cost, value added, comparable fees of

other trading venues and competition factors.610

Trading participants on the TSE are required to pay several different fees: (1) a basic monthly fee

assessed to every trading participant; (2) fees for traded stock, based on the value of the trade; (3)

fees based on the number of accesses per month (each entry, change and cancellation of an order

is considered an “access” for these purposes); and (4) trading system usage facility fees based on

the number of servers and/or terminals used.611

Proprietary trading systems

Alternative trading venues in Japan include regulated, lit proprietary trading systems and unreg-

ulated, dark venues (for both order matching and internalization) operated by FIBOs.612 A PTS is

an alternative trading platform where matching of trading orders from various FIBOs takes place

in an organized fashion.613 Operating a PTS requires both generic registration as a Type I Financial

Instruments Business and a separate authorization for operating the PTS. The authorization is

subject to having at least JPY 300 million of capital (higher than the JPY 50 million required for

607 See id at 31. 608 See IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 92 (cited in note 1). 609 See IOSCO, Trading Fee Models and their Impact on Trading Behaviour: Final Report, FR12/13 (December 2013). 610 See id. 611 See Tokyo Stock Exchange Inc., Trading Participation Fees (September 2016), available at https://www.jpx.co.jp/eng-

lish/rules-participants/participants/fees/tvdivq000000v276-att/fee(English)20160901.pdf; Tokyo Stock Exchange Inc.,

Rules regarding Trading Participant Fees, etc. (July 2, 2018), available at https://www.jpx.co.jp/english/rules-partici-

pants/rules/regulations/tvdivq0000001vyt-att/trading_participant_fees_rules_20180702.pdf 612 See IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 101-02 (cited in note 1). 613 See Working Group on Financial Markets, Agenda for competition among trading venues and alternative trading

platforms (cited in note 14).


broker-dealers, but lower than the JPY 1 billion of capital required for financial instruments ex-

changes).614

PTS must be authorized by the FSA. The applicant’s price formation method, settlement method,

business plan and business methods must ensure that public interest and investor protection are

maintained. FSA’s Supervisory Guidelines include further authorization criteria, such as internal

controls, disclosure of price information, reporting of transaction volume, etc.615

A PTS operator is also required to provide fair market access,616 which is determined as part of the

authorization process as well as ongoing monitoring of subsequent amendments to relevant

rules.617 PTS are not required to disclose trading fees, but they generally do so in practice.618

Bids and offers made on a PTS, as well as transactions completed in listed securities (and prices),

must be disclosed to members and the public.619 This information must also be provided to the

FSA.620 In practice, information on PTS is consolidated by the Japan Securities Dealers Association

(“JSDA”) and disclosed via the JSDA website.621 Accordingly, PTSs are lit venues: they have well

defined market structure and market participants with price formation taking place in the visible

order book.622

The main differences between financial instruments markets (stock exchanges) and PTS are as

follows:

(1) approval (operation of an exchange requires a license, whereas operation of a PTS only

requires authorization);

(2) capital requirements (financial instruments exchanges are required to have capitalization

of JPY 1 billion, compared to JPY 300 million for PTS);

(3) financial instruments markets have restrictions on holding of voting rights constituting 20

percent or more;

(4) financial instruments exchanges exercise (or delegate) self-regulatory functions such as

examination of member compliance, surveillance of the members’ transactions, screening

of membership qualifications, and sanctions against members who breach rules; and

(5) PTS that reach 10% market share must be licensed to become a financial instruments mar-

ket.623

614 See IMF, Financial Sector Assessment Program: Technical Note at 30 (cited in note 10). 615 See id. 616 See Cabinet Office Ordinance, Article 17(12). 617 See IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 98 (cited in note 1). 618 See id. 619 See FIEA Article 67-19. 620 See FIEA Article 67-20. 621 See IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 102 (cited in note 1). 622 See Kim, Barriers to Market Structure Evolution in Japan (cited in note 45). 623 See Working Group on Financial Markets, Agenda for competition among trading venues and alternative trading

platforms (cited in note 14).


Unregistered “dark pools”

FIBOs are allowed, without authorization as a PTS operator, to operate “dark” trading systems

whereby customer orders are electronically matched or internalized and then reported to the off-

auction trading hours trading network offered by a financial instruments exchange.624 These dark

pools began to appear in Japan around 2005 and have since become a standard product offering

for major international brokerage houses as well as some of the large domestic securities firms.625

The FSA currently plans to introduce new regulation enhancing the transparency of dark pools.

Over-the-counter market

Shares of companies that are not listed on a stock exchange or registered with the over-the-

counter (“OTC”) market are traded over the counters of securities companies; these transactions

are reported to the JSDA, but the volume of trading in these issues is limited.626

Financial instruments exchanges are required to provide pre-trade transparency, because they

must publicly display information on bids and offers.627 Separately, when entering bids or offers,

trading participants must disclose to the exchange whether the transaction is as principal or agent,

a short or margin sale,628 but this information need not be publicized more broadly.

Financial instruments exchanges also are legally required to provide post-trade transparency:

post-trade information must be publicly displayed immediately after a trade occurs.629 Financial

instruments exchanges must also publicly disclose the total volume of daily transactions, highest

price, lowest price, and closing price for each listed security. Such information must also be directly

provided to the FSA.630

The TSE publicizes pre-trade quotation information, as well as execution prices via its own market

information dissemination systems.631 Pre-trade quote information is also available to the market

via third-party distribution services, some of which integrate information from the TSE with infor-

mation from other venues, including proprietary trading systems. Exchange trade data and quote

information is available to all members in real time. The TSE also makes more detailed real-time

information available to members for additional fees.632

624 See Working Group on Financial Markets, Initiatives toward Stable Asset Building and the Development of Institu-

tional Systems related to Markets and Exchanges at 23 (cited in note 46). 625 See Kim, Barriers to Market Structure Evolution in Japan (cited in note 45); IMF, Japan: IOSCO Objectives and Princi-

ples of Securities Regulation at 102 (cited in note 1). 626 See JSRI, Securities Market in Japan at 56. 627 Cabinet Office Ordinance on Financial Instruments Business Table 1, Articles 74-75. 628 See IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 102, . 629 See FIEA Article 130. 630 See FIEA Article 131. 631 See IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 102. 632 See id at 99.


FIBOs are required to establish a policy and method for executing orders from customers under

the best terms and conditions (“Best Execution Policy”) and execute orders in accordance with

the Best Execution Policy.633 Before accepting an order from a customer, FIBOs need to deliver in

advance to the customer a document stating the Best Execution Policy. FIBOs are prohibited from

providing and promising special profits to a particular client.634 Unlike the United States and EU,

Japan does not have detailed regulations regarding best execution, including a requirement for

transparency.

All FIBOs and their directors and employees are also required to execute business in good faith

and fairly to customers.635 Conflicts of interest must be prevented and appropriate management

systems to identify them and address them must be developed.636 In addition, guidelines require

that an independent conflict of interest manager be appointed to monitor different sales lines.637

These general rules concerning conflicts of interest and best execution apply to intermediaries

routing customer orders regardless of whether those orders may be routed internally, to an affil-

iate or to another venue.638

By the middle of 2010 (after information vendors introduced PTS price information streaming, the

TSE started offering colocation services, and Japan Securities Clearing Corporation began offering

clearing services for PTS) several FIBOs in Japan revised their Best Execution Policy to address

smart order routing connections to PTSs.639 However, many FIBOs continue to use exchanges as

the default execution venue,640 especially for retail customers.

Tick sizes on the TSE vary based on share price, with lower-priced stocks having smaller tick sizes

(see table on the following page).641 Proprietary trading systems (“PTSs”) initially defined their tick

increments at about 1/10th those of the exchanges.642 Under pressure from PTSs, which began to

633 See FIEA Article 40-2. 634 See IOSCO, Order Routing Incentives: Final Report at 21. 635 See FIEA Article 36. 636 See FIEA Articles 36, 44. 637 See IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 92 (cited in note 1); IOSCO, Order Routing

Incentives: Final Report at 9, 21 (cited in note 31). 638 See id at 20. 639 Yoichi Ishikawa, Proprietary Trading Systems in Japan, Global Trading (June 15, 2010), available at

https://www.fixglobal.com/home/proprietary-trading-systems-in-japan/. 640 See, for example, Deutsche Bank Group Japan, Principles of Best Execution (May 7, 2018), available at https://ja-

pan.db.com/en/content/best_execution_policy.html. 641 See Japan Exchange Group (JPX), Trading Rules of Domestic Stocks: Tick Size (December 1, 2015), available at

https://www.jpx.co.jp/english/equities/trading/domestic/07.html. 642 See Michael Kim, Barriers to Market Structure Evolution in Japan, Global Trading (June 15, 2010), available at

https://www.fixglobal.com/home/barriers-to-market-structure-evolution-in-japan/.


directly compete with exchanges in 2005, the TSE reduced its tick sizes for highly-liquid stocks

with large market capitalizations (the TOPIX100 constituents) over three stages.643

TOPIX 100 Constituents Other issues

Price per share (JPY) Tick size (JPY) Price per share (JPY) Tick size (JPY)

p < 1,000 0.1 p < 3,000 1

1,000 < p ≤ 3,000 0.5 3,000 < p ≤ 5,000 5

3,000 < p ≤ 10,000 1 5,000 < p ≤ 30,000 10

10,000 < p ≤ 30,000 5 30,000 < p ≤ 50,000 50

30,000 < p ≤ 100,000 10 50,000 < p ≤ 300,000 100

100,000 < p ≤ 300,000 50 300,000 < p ≤ 500,000 500

300,000 < p ≤ 1,000,000 100 500,000 < p ≤ 3,000,000 1,000

1,000,000 < p ≤ 3,000,000 500 3,000,000 < p ≤ 5,000,000 5,000

3,000,000 < p ≤ 10,000,000 1,000 5,000,000 < p ≤ 30,000,000 10,000

10,000,000 < p ≤ 30,000,000 5,000 30,000,000 < p ≤ 50,000,000 50,000

30,000,000 < p 10,000 50,000,000 < p 100,000

The FIEA was amended in May 2017 (taking effect in April 2018) to specifically address algorithmic

high speed trading. “High speed trading” is defined as algorithmic trading of securities or deriva-

tives that minimizes latency by submitting orders to a trading venue (1) from a place that is adja-

cent or in proximity to the trading venue and (2) that are segregated from other orders. This

definition would include algorithmic trading using an exclusive virtual server that is located inside

a stock exchange, such as the co-location service provided by the TSE.644

Firms that engage in high speed trading are required to register with the FSA. FIBOs that are

licensed to engage in securities businesses must notify the FSA if they engage in high speed trad-

ing, but do not have to separately register as a high speed trading firm. As part of their registration

with or notification to the FSA, firms that engage high speed trading are required to provide the

FSA with information related to their trading, such as information on their strategies and key

compliance and risk controls. Required information includes: the category of each strategy (mar-

ket-making, arbitrage, etc.); the markets in which the investor conducts high speed trading; the

category of securities or listed derivatives covered by the strategy; and the names of the brokers

retained.645

643 See See Working Group on Financial Markets, Initiatives toward Stable Asset Building and the Development of Insti-

tutional Systems related to Markets and Exchanges, Financial System Council, Financial Services Agency (Japan), 20 (De-

cember 22, 2016), available at https://www.fsa.go.jp/en/refer/councils/singie_kinyu/20170509/03.pdf; Ravi Kashyap, A

Tale of Two Consequences: Intended and Unintended Outcomes of the Japan TOPIX Tick Size Changes (February 5, 2019),

available at https://arxiv.org/pdf/1602.00839.pdf. 644 FIEA Article 2(41); Cabinet Office Order on Definitions under Article 2 of the Financial Instruments and Exchange Act,

Article 26. 645 FIEA Articles 66-50, 66-51; Cabinet Office Order on Financial Instruments Business, etc., Articles 327-329..


High speed trading firms also are required to establish operational control systems by: establish-

ing company rules regarding high speed trading; providing training or other measures for em-

ployees to ensure compliance with those rules; take appropriate measures to maintain computer

systems related to high speed trading; implement necessary and appropriate measures to prevent

unfair trading through abuse of material non-public information; and implement sufficient trading

controls to prevent intentional market manipulation.646 FIBOs are prohibited from accepting or-

ders for high speed trading from firms that are not licensed and/or licensed firms for which the

FIBO is unable to confirm that its operational control system or risk controls are appropriately

implemented.647

In addition, firms that engage in high speed trading are subject to record-keeping and annual

business reporting. Foreign investors can substitute books and records made in accordance with

foreign regulations (such as MiFID II) for Japan’s high speed trading regulations. Foreign firms

that engage in high speed trading are required to retain books and records for 7 or 10 years from

the date of creation.648

The FIEA also includes separate rules governing market manipulation in Japanese securities. These

rules apply to all kinds of trading, including algorithmic trading. The FIEA prohibits conducting, or

offering to conduct, a series of purchases and sales of securities, in a manner that misleads a

person into believing that the purchase and sales of securities are thriving or causes fluctuations

in the market for the purpose of inducing the purchase and sales of securities.649 The SESC, which

is responsible for market surveillance, including inspections of financial instruments firms, inves-

tigation of market misconduct, disclosure statements inspections and criminal investigations of

securities fraud, has penalized traders for engaging in market manipulation, such as spoofing,

using algorithmic trading technology.650

Financial instruments exchanges use price limitation functions, “tick” size limitations and circuit

breakers to deal with excessive volatility.651 The TSE, for example, sets daily price limits to prevent

volatile swings in a stock’s price and provides a “time-out” in the event of a sharp rise or decline

in a stock’s price. Daily price limits are set in absolute yen values according to the previous day’s

closing price of each stock based on a sliding scale (ranging from ± JPY 30 for stocks with a price

of less than JPY 100, to ± JPY 10 million for stocks with a base price of JPY 50 million). Bids and

offers may not be placed at prices beyond the set limits: for example, if the previous day’s closing

646 FIEA Articles 66-55, 66-57; Cabinet Office Order on Financial Instruments Business, etc., Articles 336-337. 647 FIEA Article 38(viii); Cabinet Office Order on Financial Instruments Business, etc., Article 116-4. 648 FIEA Article 66-58; Cabinet Office Order on Financial Instruments Business, etc., Article 338. 649 See FIEA Article 159. 650 See Daisuke Niwa, Market Manipulation Using High Frequency Trading and Issues Facing Japan, Japan Lawyers Guide

2016/17, 38 (October 2016). 651 See IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 92 (cited in note 1).


price for a stock was JPY 1000, the lower and upper limits will be JPY 700 and JPY 1300, respec-

tively, and no trading will be allowed outside of those limits.652 On certain occasions, such as if

there are three consecutive trading days in which the stock is stuck at the upper (lower) daily price

limits, then the TSE will adjust the upper (lower) price limit.653

To prevent stock prices from fluctuating by large amounts suddenly, the TSE also delays the exe-

cution of quotes that are outside a certain range (again based on a sliding scale depending on

stock price). Rather than execute immediately, a so-called “special quote” is indicated, which gives

other investors a chance to place balancing orders. For example, if a buy order is placed at JPY

550 (outside the range) after an execution price of JPY 500 and there is no sell order below JPY

550, then a special bid quote of JPY 510 will be publicly disseminated, which will be gradually

raised every three minutes if there are no offers at the indicated price. If a counter-offer comes in,

the investor that places the bid gets the benefit of execution at the lower price (closer to the prior

execution price).654

The FSA also has the power to halt trading at an exchange in appropriate circumstances.655 How-

ever, the FSA has indicated that in practice this is not necessary as there is constant dialogue with

the exchanges.656

652 See Tokyo Stock Exchange Inc., Guide to TSE Trading Methodology, 11-14 (2015), available at

https://www.jpx.co.jp/english/equities/trading/domestic/tvdivq000000tpfi-att/Guide_to_TSE.pdf. 653 See id at 50. 654 See id at 33-37. 655 See FIEA Article 152. 656 See IMF, Japan: IOSCO Objectives and Principles of Securities Regulation at 106 (cited in note 1).


The U.S. equity markets are primarily regulated by the Securities and Exchange Commission (the

“SEC”) pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and

the rules and regulations promulgated thereunder. These regulations include Regulation National

Market System (“Reg NMS”) and Regulation Alternative Trading Systems (“Reg ATS”), which gov-

erns certain non-exchange trading venues.

Exchanges and “national securities associations” are designated as self-regulatory organizations

(“SROs”) under the Exchange Act.657 The only national securities association is the Financial Indus-

try Regulatory Authority (“FINRA”), an independent organization that regulates the securities in-

dustry.658

In practice, exchanges do not execute their SRO obligations independently. The SEC maintains a

role in regulating exchanges—exchange rules and disciplinary decisions are subject to SEC review,

and the SEC may “suspend, bar or otherwise censure” an SRO that fails in its self-regulatory re-

sponsibilities.659 With respect to rulemaking, under the Exchange Act, an SRO’s proposed rule may

not take effect until approved by the SEC660 unless it is the type of rule that becomes effective

immediately upon filing with the SEC,661 such as (i) policies and practices governing the admin-

istration of existing rules; (ii) fee changes; (iii) internal administrative rules; and (iv) certain other

rules that do not significantly affect investor protection.662 Although rarely invoked, the SEC also

has authority to unilaterally amend SRO rules.663

The Exchange Act also allows the SEC to re-allocate regulatory responsibilities among SROs.664 In

addition, SROs have voluntarily entered into Regulatory Services Agreements (“RSAs”) with other

SROs to contract out certain regulatory responsibilities.665 As a result of this ability to allocate or

657 15 U.S.C. § 78(c)(a)(26) (2012). 658 See Self-Regulatory Organization Rulemaking, U.S. SEC. & EXCH. COMM’N, https://www.sec.gov/rules/sro.shtml (last

modified Mar. 5, 2019). 659 15 U.S.C. § 78s(h)(1) (2010). 660 15 U.S.C. § 78s(b)(2). See generally, U.S. SEC. & EXCH. COMM’N, Staff Guidance on SRO Rule Filings Relating to Fees:

Subject: Fee Filings (May 21, 2019) https://www.sec.gov/tm/staff-guidance-sro-rule-filings-fees. 661 15 U.S.C. § 78s(b)(3)(A). 662 17 C.F.R. § 240.19b-4(f). In October 2019, the SEC proposed a rule rescinding the current exception that allows ex-

change fee changes to become immediately effective upon filing. U.S. SEC. & EXCH. COMM’N, Rescission of Effective-Upon

Filing Procedure for NMS Plan Fee Amendments, Exchange Act Release No. 34-87193 (Oct. 1, 2019),

https://www.sec.gov/rules/proposed/2019/34-87193.pdf. 663 15 U.S.C. § 78s(c). 664 15 U.S.C. § 78(q)(d) (2010); 17 C.F.R. § 240.17d-2 (1976). 665 See, e.g., Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Amend Chapter IX of its Rulebook,

Exchange Act Release No. 71445, File No. SR-EDGX-2014-01 2 (Jan. 30, 2014)

https://www.sec.gov/rules/sro/edgx/2014/34-71445.pdf; Self-Regulatory Organizations; New York Stock Exchange LLC;

Notice of Filing and Immediate Effectiveness of Proposed Rule Change Amending Rules 9268, 9559, and 9620, Exchange

Act Release No. 71986, File No. SRNYSE-2014-20 2 (Apr. 22, 2014) https://www.sec.gov/rules/sro/nyse/2014/34-

71986.pdf.


outsource SRO obligations, FINRA now handles many of exchanges’ self-regulatory responsibili-

ties on their behalf.666

SROs are able to exert significant influence in establishing market-wide rules through NMS Plans.

SROs must submit NMS Plans to the SEC,667 and NMS Plans (and any amendments) do not be-

come effective until they are approved by the SEC through notice-and-comment rulemaking.668

SROs’ authority to file NMS Plans originates in the Exchange Act, which allows the SEC to delegate

the development and operation of key elements of market infrastructure to the SROs.669 The Ex-

change Act and Reg NMS do not expressly restrict the scope or contents of NMS Plans, so they

can govern a wide range of important market structure issues. As a result, their contents affect

essentially every market participant, although non-SROs play a limited role in NMS plan design.

For example, the consolidated audit trail, the tick-size pilot program, and the governance of the

consolidated market data aggregators (SIPs) are all managed according to NMS Plans.670

SROs are also immune from certain types of legal liability when acting in their self-regulatory

capacity.671 SRO immunity originates from their adjudicatory and disciplinary responsibilities, but

it has expanded to encompass certain of their regulatory functions more generally.672

666 Daniel M. Gallagher, U.S. SEC. & EXCH. COMM’N, Remarks at the SRO Outreach Conference (Jan. 12, 2012)

https://www.sec.gov/News/Speech/Detail/Speech/1365171489690#.VI58F0sUybI; Robert W. Cook, FINRA, Equity Mar-

ket Surveillance Today and the Path Ahead (Sep. 20, 2017), https://www.finra.org/newsroom/speeches/092017-equity-

market-surveillance-today-and-path-ahead. 667 17 C.F.R. § 242.608(a). 668 17 C.F.R. § 242.608(b)(1). 669 See 15 U.S.C. § 78k-1(a)(3)(B) (2012). 670 See Joint Industry Plan; Order Approving the National Market System Plan Governing the Consolidated Audit Trail,

81 Fed. Reg. 84696 (Nov. 23, 2016); U.S. SEC. & EXCH. COMM’N, Statement on the Expiration of the Tick Size Pilot (Sept. 10,

2018), https://www.sec.gov/news/public-statement/tm-dera-expiration-tick-size-pilot; Second Restatement of Plan

Submitted to the Securities and Exchange Commission Pursuant to Rule 11aa3-1 under the Securities Exchange Act of

1934 (“CTA Plan”) (August 27, 2018), available at https://www.nyse.com/publicdocs/ctaplan/notifications/trader-up-

date/CTA%20Plan%20-%20Composite%20as%20of%20August%2027,%202018.pdf. 671 The precise scope of and limitations on SRO liability cvontinue to be subject to debate, but the SEC has taken the

position that (i) “absolute immunity is properly afforded to the exchanges when engaged in their traditional self-regu-

latory functions—where the exchanges act as regulators of their members” and (ii) “immunity does not properly extend

to functions performed by an exchange itself in the operation of its own market, or to the sale of products and services

arising out of those functions.” Brief of the Securities and Exchange Commission, Amicus Curiae, City of Providence at 22,

Rhode Island v. BATS Global Markets, Inc. (2nd Circuit, 2016) (No. 15-3057) https://www.sec.gov/litiga-

tion/briefs/2016/providence-bats-global-markets-1116.pdf. 672 Rohit A. Nafday, Comment, From Sense to Nonsense and Back Again: SRO Immunity, Doctrinal Bait-and-Switch, and

a Call for Coherence, 77 U. CHI. L. REV. 847, 854 (2010); Merritt Fox & Gabriel Rauterberg, Stock Market Futurism, 42 J.

CORP. L. 793, 799 (2017).


Key definitions

Alternative trading

systems or ATS

as defined by Reg ATS, any organization, association, person, group of

persons, or system: (1) that constitutes, maintains, or provides a market

place or facilities for bringing together purchasers and sellers of securities

or for otherwise performing with respect to securities the functions com-

monly performed by a stock exchange; and (2) that does not: (i) set rules

governing the conduct of subscribers other than the conduct of such sub-

scribers' trading on such organization, association, person, group of per-

sons, or system; or (ii) discipline subscribers other than by exclusion from

trading.673

Broker-dealer as defined by the Exchange Act, any person (i) “engaged in the business of

effecting transactions in securities for the account of others” (a “broker”)674

and (ii) “engaged in the business of buying and selling securities… for such

person’s own account through a broker or otherwise” (a “dealer”).675

Broker-dealer

internalization

trading activity whereby a broker-dealer systematically executes customer

orders as a principal against the broker-dealer’s own inventory of stocks

(instead of routing them to an exchange or alternative trading system).676

Exchange as defined by the Exchange Act, “any organization… whether incorporated

or unincorporated, which constitutes, maintains, or provides a marketplace

or facilities for bringing together purchasers and sellers of securities.”677

Exchange Act the Securities Exchange Act of 1934, as amended.

National best bid

and national best

offer or NBBO

as defined by Reg NMS, with respect to quotations for a given security, the

best bid and best offer for such security that are calculated and dissemi-

nated on a current and continuing basis by a plan processor pursuant to

an effective national market system plan.678

National market

system plan or NMS

plan

as defined by Reg NMS, “any joint self-regulatory organization plan in con-

nection with: (i) The planning, development, operation or regulation of a

national market system (or a subsystem thereof) or one or more facilities

thereof; or (ii) the development and implementation of procedures and/or

673 17 C.F.R. § 242.300(a). Though ATSs meet the Exchange Act definition of an exchange, they are not required to

register as exchanges so long as meet the regulatory requirements of Reg ATS. Under Reg ATS, ATSs are generally

subject to a lighter regulatory regime than exchanges. 674 Definitions and application, 15 U.S.C. § 78c(a)(4). 675 Id. at § 78c(a)(5). 676 Commission Request for Comment on Issues Relating to Market Fragmentation, Exchange Act Release No. 42450,

File No. SR-NYSE-99-48 (Feb. 23, 2000), https://www.sec.gov/rules/sro/ny9948n.htm (“Internalization is the routing of

order flow by a broker to a market maker that is an affiliate of the broker. An integrated broker-dealer, for example,

internalizes orders by routing them to the firm's market-making desk for execution.”). 677 Definitions and application, 15 U.S.C. § 78c(a)(1). 678 17 C.F.R. § 242.600(b)(43).


facilities designed to achieve compliance by self-regulatory organizations

and their members with any section of this Regulation NMS.”679

NMS stock any stock listed on a national securities exchange.680

Reg ATS the Regulation ATS, which concerns the regulation of alternative trading

systems.

Reg NMS the Regulation NMS, which concerns the regulation of the national market

system.

Trading venue exchanges, alternative trading systems, and broker-dealer internalizers.

Until the mid-2000s, the U.S. equity markets were dominated by exchange-based floor trading.

This manual market landscape had some marked differences from the modern structure. For ex-

ample, trading was highly centralized and competition among trading venues was limited. At the

same time, there are similarities between the manual and modern market structure, such as the

existence of undisplayed or “dark” trading and broker-dealer internalization.

Once automated electronic communication systems proliferated in the late 1990s, broker-dealers

began to use these technologies to implement trading systems that challenged the dominance of

the exchange-based manual model. In 1998, the SEC adopted Regulation ATS (“Reg ATS”), sub-

jecting these trading venues to regulation.

Despite the advent of electronic marketplaces, certain regulations that were in place until 2006

gave a competitive advantage to slower manual markets for exchange-listed stocks. In 2006, the

implementation of Regulation National Market System (“Reg NMS”) reshaped the equity market

regulatory structure by spurring competition among trading venues, leading to the automation

of equity markets and lowering investor transaction costs.

As of September 2017, dark trading accounted for approximately 45% of trading in U.S. equity

markets, largely flat since 2014.681 It can take place across all three types of trading venues.682 The

vast majority of trading on ATSs and broker-dealer internalization can be considered dark trading,

and approximately 9% of trading on exchanges involves the execution of undisplayed interest.683

679 17 C.F.R. § 242.600(b)(44). 680 Rule 600(b)(46) of Reg NMS defines NMS security as “any security or class of securities for which transaction reports

are collected, processed, and made available pursuant to an effective transaction reporting plan…,” and Rule 600(b)(47)

defines NMS stock as an NMS security other than an option. 17 C.F.R. § 242.600 (2005). See also Memorandum from SEC

Division of Trading and Markets to SEC Market Structure Advisory Committee, Rule 611 of Regulation NMS, U.S. SEC. &

EXCH. COMM’N 3 (Apr. 30, 2015) (“An NMS stock generally means any exchange-listed security (other than listed options)

for which consolidated market data is disseminated.”). 681 COMM. ON CAP. MKTS REG., The State of the U.S. Equity Markets (Sept. 2017), https://www.capmktsreg.org/wp-con-

tent/uploads/2017/10/2017-CCMR-EMS-Empirical-Updates.pdf. 682 OECD, Changing business models of stock exchanges and stock market fragmentation, in OECD Business and Finance

Outlook 2016, 127, 130–1 (2016), available at https://www.oecd.org/daf/ca/BFO-2016-Ch4-Stock-Exchanges.pdf. 683 Id. at 126.


There are no caps on dark trading in U.S. equity markets. However, any dark trading must occur

in a manner consistent with Reg NMS.

Stock exchanges

The Exchange Act defines an exchange as “any organization, association, or group of persons,

whether incorporated or unincorporated, which constitutes, maintains, or provides a market place

or facilities for bringing together purchasers and sellers of securities.”684 The Exchange Act pro-

vides that an exchange may seek to register as a “national securities exchange” by publicly filing

an application with the SEC.685

The key requirements that apply to exchanges are set forth in the Exchange Act and in regulations

promulgated thereunder by the SEC. Under the Exchange Act, exchanges must permit any regis-

tered broker-dealer in good standing to become a member of the exchange.686 Exchanges must

file their proposed rules, which cover trading at the exchange and member conduct, for public

comment and SEC approval before they can go into effect.687 In addition, exchanges are the only

trading venues that are “self-regulatory organizations” (“SROs”).688 As SROs, exchanges must have

the capacity to carry out the purposes of the Exchange Act and to enforce compliance by their

members with the Exchange Act and related exchange rules.689 Such enforcement is generally

achieved through disciplinary proceedings and membership restrictions, for which the Exchange

Act also sets forth guidelines.690

Alternative trading systems

In 1998, the SEC implemented Reg ATS and established a new category of trading venue regula-

tion, the alternative trading system (“ATS”).691 This new type of trading venue was designed to

respond to the proliferation of automated trading platforms that market participants had devel-

oped, which “furnish[ed] services traditionally provided solely by registered exchanges.”692 Alt-

hough these electronic venues meet the Exchange Act definition of exchange, Reg ATS exempts

them from exchange registration if they comply with Reg ATS and their operators are registered

as broker-dealers.693

684 15 U.S.C. § 78c(a)(1) (2010). 685 Id. at § 78f. 686 Id. at § 78f(b)(2). 687 Id. at § 78s(b); SEC Form 19b-4, available at https://www.sec.gov/about/forms/form19b-4.pdf. 688 Id. at § 78s(a). 689 Id. at § 78f(b)(1). 690 Id. at § 78f(c),(d). 691 Regulation of Exchanges and Alternative Trading Systems, Exchange Act Release No. 40760, File No. S7-12-98 (Dec.

8, 1998), https://www.sec.gov/rules/final/34-40760.txt (“Reg ATS Release”). 692 Reg ATS Release. 693 Id.


Reg ATS requires that an ATS’s rules can only pertain to its subscribers’ trading conduct,694 and

ATSs can only discipline subscribers by excluding them from trading.695 Unlike an exchange, an

ATS can effect trading rules without the SEC’s preapproval.696 ATSs can also limit access to trading

on their platform and can restrict participation among its subscribers, unless their average daily

trading volume in a particular stock equals or exceeds approximately 5% of overall trading volume

in that stock.697 If trading volume on an ATS exceeds the 5% threshold, then the ATS must establish

written standards for granting open access to all registered broker-dealers seeking to trade that

stock on the ATS.698

ATSs are not required to publicly display orders, unless: (1) their trading volume in a stock equals

or exceeds 5% of total trading in that stock; and (2) the ATS displays prices to more than one of

its participants (i.e., it is not a “dark pool”).699 If an ATS exceeds the 5% threshold, then it must

publicly display orders in that stock,700 but no ATSs presently exceed the threshold.

The SEC amended Reg ATS in July 2018 to enhance operational transparency and regulatory over-

sight of ATSs.701 The new rule requires ATSs to file and update a Form ATS-N with the SEC, which

will be made publicly available.702 Form ATS-N requires public disclosure for the first time of in-

formation regarding each ATS’s rules, services, fee structures, trading activity by the operators,

and procedures regarding confidential customer information.703

Order protection rule

An order that is executed at a worse price than the best publicly available price is known as a

“trade-through.” The SEC adopted Rule 611 of Reg NMS (the “order protection rule”) to reduce

trade-throughs by requiring exchanges, ATSs and broker-dealer internalizers to establish, main-

tain, and enforce written policies and procedures that are reasonably designed to prevent trade-

694 17 C.F.R. § 242.300. 695 Id. 696 Regulation of Exchanges and Alternative Trading Systems, 63 Fed. Reg. 70844, 70864 (Dec. 22, 1998)

https://www.gpo.gov/fdsys/pkg/FR-1998-12-22/pdf/98-33299.pdf (“Form ATS is not an application and the [SEC] would

not ‘approve’ an ATS before it began to operate. Form ATS is, instead, a notice to the [SEC].”). 697 17 C.F.R. § 242.301(b)(5). The Fair Access Rule applies on a “security-by security basis.” See Regulation of Exchanges

and Alternative Trading Systems, 63 Fed. Reg. 70844, 70873 (Dec. 22, 1998) https://www.gpo.gov/fdsys/pkg/FR-1998-

12-22/pdf/98- 33299.pdf. 698 17 C.F.R. § 242.301(b)(5)(ii)(C) and (d) also establish related record-keeping and reporting requirements. 699 Memorandum from SEC Division of Trading and Markets to SEC Market Structure Advisory Committee, Current

Regulatory Model for Trading Venues and for Market Data Dissemination, U.S. SEC. & EXCH. COMM’N 4 (Oct. 20, 2015),

https://www.sec.gov/spotlight/emsac/memo-regulatory-model-for-trading-venues.pdf 700 17 C.F.R. §§ 242.301(b)(3) and (5). 701 U.S. SEC. & EXCH. COMM’N, SEC Adopts Rules to Enhance Transparency and Oversight of Alternative Trading Systems

(July 18, 2018), https://www.sec.gov/news/press-release/2018-136. See also DAVIS POLK, SEC Adopts New Transparency

Requirements for NMS Stock Alternative Trading Systems (Aug. 21, 2018). 702 U.S. SEC. & EXCH. COMM’N, Form ATS-N Filings and Information, https://www.sec.gov/divisions/marketreg/form-ats-

n-filings.htm (last accessed Apr. 16, 2019). 703 U.S. SEC. & EXCH. COMM’N, Regulation of NMS Stock Alternative Trading Systems, 83 FED. REG. 38768 (Aug. 7, 2018),

https://www.govinfo.gov/content/pkg/FR-2018-08-07/pdf/2018-15896.pdf. .


throughs of “protected quotations.”704 Protected quotations are the best, automated,705 publicly

displayed bids and offers on each exchange and the Alternative Display Facility operated by FINRA

(which would include publicly displayed quotes from ATSs if they exceeded the 5% threshold, but

none have).706 While the rule restricts order execution at a price worse than the NBBO, trading

venues can execute at a price matching the NBBO, even if they are not publicly displaying that

price.707

Trading venue execution disclosures

To enhance transparency with respect to order execution, Rule 605 of Reg NMS requires all trading

venues (including exchanges, ATSs, and broker-dealer internalizers) to publicly disclose monthly

reports with standardized information about the order execution quality they achieve for retail-

size customer orders.708 The report must contain detailed information categorized by individual

security, order type, and order size for all securities that the trading venue executes.709 It must

include the speed at which orders are executed and the “average realized spread” (calculated with

reference to the weighted price obtained versus the midpoint of the NBBO).710

As to speed, Rule 605 currently requires trading venues to disclose the speed of execution to the

tenth of a second.711 As to price, execution quality reported under Rule 605 is measured using

the NBBO as disseminated by the SIP feeds.712 In emphasizing the required use of SIP-based

NBBOs, the SEC staff has explained that benchmarking executions across market centers to the

same reference points would further the important objective of generating “execution quality sta-

tistics that are comparable among different market centers.”713

704 Order Protection Rule, 17 C.F.R. § 242.611. 705 Automated quotations are displayed by an automated trading centre, and the definitions of both automated quo-

tations and automated trading centre generally require that quotations be immediately and automatically executable,

without any programmed delay. Regulation NMS, Adopting Release 70 FR 37496 (June 29, 2005). 706 NMS Security Designation and Definitions, 17 C.F.R. § 242.600(b)(61)-(62) (defining “protected quotation”); FIN. IN.

REG. AUTH., Alternative Display Facility (ADF) (last accessed Sept. 20, 2019), https://www.finra.org/filing-reporting/alter-

native-display-facililty-adf. 707 Rule 611 of Regulation NMS, Memorandum from SEC Division of Trading and Markets to SEC Market Structure

Advisory Committee, at 4 (Apr. 30, 2015), https://www.sec.gov/spotlight/emsac/memo-rule-611-regulation-nms.pdf

(“Rule 611 only restricts trades at prices worse than a protected quotation. Any trading center is free to execute trades

at prices that are equal to or better than a protected quotation, regardless of whether such trading center is currently

quoting at that price or is a dark venue that never displays quotations.”). 708 See generally 17 C.F.R. § 242.605 (2005). 709 Id. at § 242.605(a). 710 Id. at § 242.605(a)(1)(i)(K). 711 Id. at § 242.605. 712 U.S. SEC. & EXCH. COMM’N, Division of Market Regulation: Staff Legal Bulletin No. 12R (Revised) (June 22, 2001),

https://www.sec.gov/interps/legal/slbim12a.htm. 713 Id. (“One of the important objectives of the Rule is to generate execution quality statistics that are comparable among

different market centers. Benchmarking the order executions of all market centers to a Consolidated BBO with a single

time will further this objective.”).


Together, these obligations assist investors, regulators, trading venues and broker-dealers in as-

sessing effective compliance with the duty of best execution.

Access fees

Investors would not be able to obtain the best prices for their orders if broker-dealers could not

access trading venues in a fair and efficient manner. Rule 610 of Reg NMS sets forth the rules by

which market participants may access trading venues.714

Trading venues have the authority to impose “access fees” on market participants executing trades

on their platform.715 This is subject, however, to the overall requirements of the Securities Ex-

change Act of 1934, including the requirements of Section 6 that, among other things, an ex-

change’s rules must provide for the ‘equitable allocation of reasonable dues, fees, and other charges

among its members and issuers and other persons using its facilities’, not ‘permit unfair discrimina-

tion between customers, issuers, brokers, or dealers’, and ‘not impose any burden on competition

not necessary or appropriate in furtherance of the purposes of’ the Securities Exchange Act.

SROs/exchanges must have their rules and proposed rule changes approved by the SEC.716 Since

the Dodd-Frank Act in 2010, the exchanges have an option to designate their fee rules as imme-

diately effective upon filing with the SEC,717 but the SEC can suspend such an immediately effective

rule.718 In October 2019, to strengthen the considered review of fee changes, the SEC proposed

to rescind the current exception allowing exchange fee changes to become immediately effective

upon filing.719

Because access fees are not expressly reflected in a stock’s publicly displayed price, and SEC Rule

611 mandates that best price protected quotes must be honored, the SEC implemented an access

fee cap of $0.0030 per share for publicly displayed orders.720 In practice, exchanges often charge

the regulatory maximum as part of the “maker-taker” pricing system, whereby exchanges charge

a fee to the market participants that remove (“take”) liquidity from an exchange and pay a rebate

to market participants that provide (“make”) liquidity to an exchange. Access fees are generally

used to fund liquidity rebates, and exchanges earn the difference.

Access fee pilot program

In December 2018, the SEC adopted Rule 610T of Regulation NMS to implement a transaction fee

pilot program (the “Fee Pilot”) to “help the Commission analyze the effects of exchange transac-

714 Access to Quotations, 17 C.F.R. § 242.610. 715 See Memorandum from SEC Division of Trading and Markets to SEC Market Structure Advisory Committee, Maker-

Taker Fees on Equities Exchanges, U.S. SEC. & EXCH. COMM’N 29 (Oct. 25, 2015), https://www.sec.gov/spotlight/em-

sac/memo-maker-taker-fees-onequities-exchanges.pdf. 716 Section 19 of the Exchange Act of 1934 (15. U.S. Code § 78s). 717 Section 19(b)(3)(A) of the Exchange Act of 1934 (15. U.S. Code § 78s(b)(3)(A)). 718 Section 19(b)(3)(C) of the Exchange Act of 1934 (15. U.S. Code § 78s(b)(3)(C)). 719 U.S. SEC. & EXCH. COMM’N, Rescission of Effective-Upon Filing Procedure for NMS Plan Fee Amendments, Exchange Act

Release No. 34-87193 (Oct. 1, 2019), https://www.sec.gov/rules/proposed/2019/34-87193.pdf. 720 Access to Quotations, 17 C.F.R. § 242.610.


tion fee and rebate pricing models on order routing behavior, execution quality, and market qual-

ity generally.”721 The Fee Pilot covers all exchanges and is to last one year with the prospect of a

one-year extension by the SEC.722 The Fee Pilot will include stocks that meet certain trading vol-

ume and price thresholds (the “Fee Pilot Securities”).723

The Fee Pilot Securities are divided into three groups. For Test Group 1, the access fee cap appli-

cable to exchanges is reduced to $0.0010.724 For Test Group 2, the access fee cap applicable to

exchanges remains at $0.0030, but rebates are generally prohibited.725 For the Control Group, the

access fee cap applicable to exchanges remains at $0.0030.726

In addition, the Fee Pilot requires exchanges to post the following to their websites: (i) transaction

fee and rebate data on a monthly basis; and (ii) information about the Fee Pilot Securities they list

and any changes to trading in those securities.727 Exchanges must also provide the SEC with ag-

gregated order routing data on a monthly basis.728

The access fee pilot program reduces the ability of exchanges to implement a maker-taker pricing

system. Three exchange groups (NYSE, Nasdaq and Cboe Global Markets) have sued the SEC to

challenge the Fee Pilot729 on the grounds that it is arbitrary and capricious and exceeds the SEC’s

rulemaking authority under the Administrative Procedure Act.730

Market data fees

The US has a two-pronged system of market data (and market access) in equity markets, (1) the

consolidated data feeds distributed pursuant to joint-SRO national market system plans; and (2)

the proprietary data products and access services that are provided directly by the exchanges.731

721 U.S. SEC. & EXCH. COMM’N, SEC Adopts Transaction Fee Pilot for NMS Stocks (Dec. 2018),

https://www.sec.gov/news/press-release/2018-298 (“SEC Release on Transaction Fee Pilot”). See also U.S. SEC. & EXCH.

COMM’N, Transaction Fee Pilot for NMS Stocks, Exchange Act Release No. 34-84875 (effective Apr. 22, 2019),

https://www.sec.gov/rules/final/2018/34-84875.pdf. 722 SEC Release on Transaction Fee Pilot. 723 Id. 724 Id. 725 Id. 726 Id. 727 Id. 728 Id. 729 Alexander Osipovich and Dave Michaels, Big Three Stock Exchanges Sue SEC Over Trading-Fee Plan, THE WALL ST. J.

(Feb. 15, 2019), https://www.wsj.com/articles/nasdaq-joins-new-york-stock-exchange-in-suing-to-block-sec-rule-

11550259637. 730 Petition for Review at 1, The Nasdaq Stock Market LL v. U.S. Sec. & Exch. Comm’n, No. 19-1042 (D.C. Cir. Feb. 15,

2019) (invoking the applicable subsection of the Administrative Procedure Act); Scope of review, 5 U.S.C. § 706 (setting

forth the applicable standards of review, including if an administrative action is “arbitrary, capricious, an abuse of dis-

cretion, or otherwise not in accordance with law” or “in excess of statutory jurisdiction”). 731 Brett Redfearn (Director, SEC Division of Trading and Markets), ‘Opening Statement at the SEC Staff Roundtable on

Market Data and Market Access’, Oct. 25, 2018, available at https://www.sec.gov/news/public-statement/statement-

redfearn-102518.


The latter set of products has less latency, include slightly different content (for example, propri-

etary feeds have depth of book information, which the SIPs do not, and SIPs have certain regula-

tory information, which the proprietary feeds do not), and is more costly.732 The cost of the pro-

prietary data products has been increasing over time and has become a contentious issue be-

tween the users and the dominant exchanges (NYSE and Nasdaq) who have the most valuable

data streams.733

The SEC issued guidance on May 21, 2019, as to the level of detail it expects to see from the

exchanges when they seek to increase the fees they charge for market data. The details required

include measuring down to the microsecond a faster data product, and showing the costs of pro-

ducing data, if exchanges are using the cost as a basis for justifying their higher fees.734

Pursuant to the Exchange Act, the SEC aims to ensure that market participants have access to

consolidated market data at fair cost and in an effective and timely manner.735 Consolidated mar-

ket data generally refers to: (1) pre-trade transparency – timely information on the best-priced

publicly displayed quotations; and (2) post-trade transparency – timely reports of trades that are

executed.736

“Lit” trading, or trading with pre-trade transparency, refers to trading on venues with publicly

displayed quotes that include: (1) the stock symbol, (2) whether the order is one to buy or to sell,

(3) the number of shares, and (4) the price.737 Undisplayed or “dark” trading describes trades that

are executed on venues without such pre-trade transparency and the execution of undisplayed

interest on an otherwise lit venue.738 Pre-trade transparency serves an essential linkage function

by helping to inform the public of the best displayed prices for stocks.739 There are no pre-trade

732 Id. 733 IEX claims that the market data fees charged by the dominant US exchanges are 1,500 per cent times the cost of

producing the data, when compared with its own data costs, see Henderson, ‘Regulator calls on US exchanges to justify

increases in data fees’ (FT, May 21, 2019) and Henderson, ‘‘Flash Boys’ exchange IEX backs regulator in data fees fight’

(FT, May 14, 2019). See also the significant percentage change in spending on NYSE proprietary data in the period 2010

– 2017, according to Expand Research/SIFMA Analysis 2018, set out in Stafford, ‘MEMX turn up the heat on US stock

exchanges’ (FT, January 9, 2019). 734 ‘Staff Guidance on SRO Rule Filings Relating to Fees’, May 21, 2019, available at https://www.sec.gov/tm/staff-guid-

ance-sro-rule-filings-fees. 735 See generally 15 U.S.C. § 78k–1 (2012). See also Regulation NMS, Exchange Act Release No. 51808, 70 Fed. Reg.

37496, 37560, 37567 (June 29, 2005), https://www.sec.gov/rules/final/34-51808fr.pdf. 736 Concept Release on Equity Market Structure, Exchange Act Release No. 61358, File No. S7- 02-10, 75 FED. REG. 3594,

3600 (proposed Jan. 21, 2010). 737 SIFMA Paper on Displayed and Non-Displayed Liquidity, SEC. INDUS. & FIN. MKT. ASS’N 3 (Aug. 31, 2009). 738 Robert Bloomfield et al., Hidden Liquidity: Some New Light on Dark Trading, 70 J. OF FIN. 2227–74 (Oct. 2015). 739 Concept Release on Equity Market Structure, Exchange Act Release No. 61358, File No. S7-02-10, 75 FED. REG. 3594,

3600 (proposed Jan. 21, 2010).


transparency obligations in relation to odd lots,740 although some exchanges do provide odd lot

quotations.741

Trades executed in the dark are still subject to “post-trade transparency.”742 Post-trade transpar-

ency together with pre-trade transparency enables investors to monitor the prices at which orders

are executed and assess whether their orders received best execution.743

Trading venues and broker-dealers must have access to consolidated market data in order to

comply with the order protection rule and duty of best execution.

There are two ways that market participants can obtain consolidated market data. The first is via

the securities information processors (“SIPs”), which are governed by Reg NMS plans. Each NMS

plan utilizes one SIP, and there are currently two SIPs operated by a committee of exchanges: one

for Nasdaq-listed securities (under the UTP Plan), and another for securities listed on NYSE and

other exchanges (under the CTA Plan).744 Reg NMS requires trading venues to submit real-time

quotation and trade information to the SIPs, which aggregate and disseminate consolidated mar-

ket data.745 According to Reg NMS, consolidated data for each individual NMS stock must be

disseminated through a single SIP under an NMS Plan.746 Because NMS Plans must designate a

single SIP for each NMS Stock and only SROs are permitted to file NMS Plans, SROs determine

the SIP for each NMS Stock.747 SROs charge market participants to access SIP data. Although the

740 An odd lot is an order for an amount of a security that is less than the normal unit of trading for that particular

security, so that in practice odd lots are generally defined as trades at less than 100 shares (the 100-share definition

does not cover stock like Berkshire Hathaway Inc, which has a very high per share price). See SEC, ‘Odd Lot Rates in

Post-Transparency World’, Jan. 9, 2014, available at https://www.sec.gov/marketstructure/research/highlight-2014-

01.html#.XPbbnS2ZOi4. 741 See the IEX comment that ‘current exchanges vary in how they handle odd-lots’ and the SEC observation that the

‘Commission is not aware of any evidence that the non-display of odd lot orders through proprietary market data feeds

would systematically disadvantage retail investors’ in SEC Order in the Matter of the Application of Investors’ Exchange

LLC for Registration as a National Securities Exchange (June 17, 2016), page 47. 742 FINANCIAL INDUSTRY REGULATORY AUTHORITY, National Market System Plans, http://www.finra.org/industry/national-mar-

ket-system-plans (last accessed Apr. 18, 2019). Post-trade transparency covers odd lots, see the orders approving

amendments to the UTP (Unlisted Trading Privileges) Plan (Release No. 34-70793) and CTA (Consolidated Trade Asso-

ciation) Plan (Release No. 34-70794), October 31, 2013 and SEC, ‘Odd Lot Rates in Post-Transparency World’, January

9, 2014. 743 Concept Release on Equity Market Structure, Exchange Act Release No. 61358, File No. S7-02-10, 75 FED. REG. 3594,

3600 (proposed Jan. 21, 2010). 744 Jeff Kimsey, Nasdaq Sets the Record Straight About the SIP, NASDAQ (Oct. 25, 2016), https://business.nasdaq.com/mar-

ketinsite/2016/Nasdaq-Sets-the-Record-Straight-About-the-SIP.html (“There are two SIPs for cash equities, the Con-

solidated Tape Association (CTA) SIP (for New York Stock Exchange-listed securities) and the UTP SIP (for Nasdaq-listed

securities), that are operated by a committee of exchanges.”). See also, UNLISTED TRADING PRIVILEGES, Overview,

https://www.utpplan.com/ (last accessed Apr. 25, 2019); Consolidated Tape Association, Home Page, https://www.cta-

plan.com/index (last accessed Apr. 25, 2019). 745 17 C.F.R. § 242.602; Regulation NMS, Exchange Act Release No. 51808, 70 Fed. Reg. 37496 (Jun. 29, 2005)

https://www.sec.gov/rules/final/34-51808fr.pdf. 746 17 C.F.R. § 242.603(b) (“Such plan or plans shall provide for the dissemination of all consolidated information for an

individual NMS stock through a single plan processor.”). 747 Id. (“Every national securities exchange on which an NMS stock is traded and national securities association shall act

jointly pursuant to one or more effective national market system plans to disseminate consolidated information. …


SEC must approve SIP fees, changes to them can be deemed effective when filed with the SEC.748

Under Rule 603(a)(1) of Reg NMS, when a trading venue distributes core data for NMS Stocks

through a SIP, the data must be sold “on terms that are fair and reasonable.”749

Second, market participants can also privately purchase core and non-core market data directly

from trading venues and consolidate it themselves. Reg NMS permits trading venues to sell access

to their own “proprietary” data feeds, which are used for this purpose.750 Rule 603(a)(2) of Reg

NMS requires all trading venues that sell these proprietary data feeds to make their data feeds

available “on terms that are not unreasonably discriminatory.”751

In October 2018, pursuant to this statutory authority and Rule 603(a) of Reg NMS,752 the SEC set

aside core market data fee increases by NYSE Arca and Nasdaq on the grounds that the exchanges

failed to meet the burden of showing the fees are fair and reasonable.753 In light of that decision,

the SEC also remanded several other challenges to exchange fees for the exchanges to further

review the fee increases (with respect to fairness and reasonableness) and develop procedures to

assess their validity under the Exchange Act and, “if appropriate, resubmission to the Commis-

sion.”754 Several motions to reconsider the remand order remain pending before the SEC.755

The duty of best execution requires broker-dealers to execute customer trades at the most favor-

able terms reasonably available under the circumstances. It derives, in part, from common law

principles that obligate an agent to act exclusively in its principal’s best interest, and also has been

incorporated explicitly in FINRA rules. Accordingly, broker-dealers that are FINRA members have

Such plan or plans shall provide for the dissemination of all consolidated information for an individual NMS

stock through a single plan processor.”). 748 Id. at § 242.608(b)(3). 749 17 C.F.R. § 242.603(a)(1). 750 See Regulation NMS, Exchange Act Release No. 51808, 70 Fed. Reg. 37496, 37567 (June 29, 2005),

https://www.sec.gov/rules/final/34-51808fr.pdf. 751 Distribution, consolidation, and display of information with respect to quotations for and transactions in NMS stocks,

17 C.F.R. § 242.603(a). See also the section on Access Rules and Fees below. 752 The overarching Securities Exchange Act of 1934 provisions relevant to market data fees are sections 6, 11 and 19. 753 In the Matter of the Application of Securities Industry and Financial Markets Association for Review of Action taken

by NYSE Arca, Inc. and Nasdaq Stock Market LLC, U.S. SEC. & EXCH. COMM’N, Exchange Act Release No. 84432 (Oct. 16,

2018), https://www.sec.gov/litigation/opinions/2018/34-84432.pdf. 754 In the Matter of the Application of Securities Industry and Financial Markets Association and Bloomberg L.P., U.S.

SEC. & EXCH. COMM’N, Exchange Act Release No. 84433 (Oct. 16, 2018), https://www.sec.gov/litigation/opinions/2018/34-

84433.pdf. 755 In the Matter of the Application of Securities Industry and Financial Markets Association and Bloomberg L.P., U.S.

SEC. & EXCH. COMM’N, Exchange Act Release No. 84827 (Dec. 14, 2018), https://www.sec.gov/litigation/opinions/2018/34-

84827.pdf.


best execution duties whether they are acting as an agent on behalf of a customer or whether

they are trading with a customer in a principal capacity with a customer.756

FINRA’s best execution rule requires that, “[i]n any transaction for or with a customer or a customer

of another broker-dealer, a member and persons associated with a member shall use reasonable

diligence to ascertain the best market for the subject security and buy or sell in such market so

that the resultant price to the customer is as favorable as possible under prevailing market con-

ditions.”757 Broker-dealers must consider a number of factors to help them identify the best terms

reasonably available. The factors that are considered in determining whether a firm has used “rea-

sonable diligence” include: (1) the character of the market for the security (e.g., price, volatility,

relative liquidity and pressure on available communications); (2) the size and type of transaction;

(3) the number of markets checked; (4) accessibility of the quotation; and (5) the terms and con-

ditions of the order which result in the transaction.758

Broker-dealer internalization

Broker-dealer internalization generally involves a broker-dealer executing customer orders

against its own inventory of stocks.759 Broker-dealer internalizers do not meet the Exchange Act

definition of an exchange, because they primarily execute trades as a principal and only inci-

dentally match the undisplayed orders of their customers.760 Accordingly, they do not have to

register as an exchange under the Exchange Act or an ATS under Reg ATS. Instead, broker-dealer

internalizers must register as members of FINRA.761 FINRA membership carries with it a number

of regulatory obligations, such as examination, licensing, and reporting requirements.762 Further,

broker-dealer internalizers are subject to additional SEC requirements if they meet the definition

of “market center,” including the requirement to file Rule 605 execution quality reports.763

756 See FINRA, Best Execution: Guidance on Best Execution Obligations in Equity, Options and Fixed Income Markets, Reg-

ulatory Notice 15-46 (Nov. 2015), available at http://www.finra.org/sites/default/files/notice_doc_file_ref/Notice_Regu-

latory_15-46.pdf. 757 See FINRA Rule 5310. 758 See FINRA Rule 5310(a)(1). 759 Commission Request for Comment on Issues Relating to Market Fragmentation, Exchange Act Release No. 42450,

File No. SR-NYSE-99-48 (Feb. 23, 2000) https://www.sec.gov/rules/sro/ny9948n.htm (“Internalization is the routing of

order flow by a broker to a market maker that is an affiliate of the broker. An integrated broker-dealer, for example,

internalizes orders by routing them to the firm's market-making desk for execution.”). 760 17 CFR § 240.3b-16(b) (“An organization [is not an exchange] solely because such organization… allows persons to

enter orders for execution against the bids and offers of a single dealer; and… as an incidental part of these activities,

matches orders that are not displayed to any person other than the dealer and its employees[.]”); U.S. SEC. AND EXCH.

COMM’N, Regulation of Exchanges and Alternative Trading Systems (Dec. 8, 1998) https://www.sec.gov/rules/final/34-

40760.txt (“Rule 3b-16 explicitly excludes those systems that the Commission believes perform only traditional broker-

dealer activities. … Rule 3b-16 now expressly excludes the following systems from the revised interpretation of “ex-

change”: … systems that allow persons to enter orders for execution against the bids and offers of a single dealer.”). 761 See, e.g., Brokers, FINRA, available at http://www.finra.org/investors/brokers. 762 Id. 763 17 C.F.R. § 242.600(b)(52) (2005). OTC market makers are considered “market centers” under Regulation NMS. See

17 C.F.R. § 242.600(b) (38),(52) (2005). Market centers are required to produce Rule 605 reports. See 17 C.F.R. § 242.605

(2005).


Payment for order flow

Retail broker-dealers often route their orders to broker-dealer internalizers acting as market mak-

ers in the relevant security in order to obtain price improvement. These broker-dealer internalizers

often execute retail orders as part of payment for order flow (“PFOF”) agreements with the retail

broker-dealer. 764 Under a typical PFOF agreement, the broker-dealer internalizer pays the retail

brokerage to direct retail order flow to the broker-dealer internalizer for execution.765 Broker-

dealer internalizers compete to offer price improvement to the best publicly displayed price avail-

able on an exchange.766 Rule 606 of Reg NMS requires retail brokerages to report information

about their PFOF arrangements in quarterly public filings.767

Broker order-routing disclosure rule

On November 2, 2018, the SEC amended Rule 606 of Reg NMS to require greater disclosure from

broker-dealers with respect to order routing, payments to and from trading venues, payments for

order flow, and maker-taker arrangements.768

Newly-adopted Rule 606(b)(3) requires a broker-dealer, upon the request of an institutional cus-

tomer, to provide its customer with disclosures concerning the handling, routing and execution

of customer orders, including fees paid and rebates received from trading venues.769 Prior to the

amendments, Rule 606(a) already required, among other things, broker-dealers that route cus-

tomer orders to provide a quarterly public report with order routing information, including a de-

scription of the material aspects of their relationships with the venues to which they routed the

most orders (“Specified Venues”).770 Under the new rule as amended, this includes the top ten

venues as well as any venue to which the broker routed more than 5% of its non-directed orders.771

Amendments to Rule 606(a) require that: “for each Specified Venue, the broker-dealer report the

764 Memorandum from SEC Division of Trading and Markets to SEC Equity Market Structure Advisory Committee, Certain

Issues Affecting Customers in the Current Equity Market Structure, U.S. SEC. & EXCH. COMM’N 2 (Jan. 26, 2016)

https://www.sec.gov/spotlight/equity-market-structure/issues-affecting-customers-emsac012616.pdf (referring to

Concept Release on Equity Market Structure, Exchange Act Release No. 61358, File No. S7-12-98 20 (Jan. 14, 2010),

available at https://www.sec.gov/rules/concept/2010/34-61358.pdf). A marketable order is an order to buy or sell a

stock at the best publicly displayed price. 765 See, e.g., Memorandum from SEC Division of Trading and Markets to SEC Market Structure Advisory Committee,

Certain Issues Affecting Customers in the Current Equity Market Structure, U.S. SEC. & EXCH. COMM’N 5 (Jan. 26, 2015)

https://www.sec.gov/spotlight/equity-market-structure/issues-affecting-customers-emsac012616.pdf. 766 See Memorandum from SEC Division of Trading and Markets to SEC Market Structure Advisory Committee, Certain

Issues Affecting Customers in the Current Equity Market Structure, U.S. SEC. & EXCH. COMM’N 6 (Jan. 26, 2015)

https://www.sec.gov/spotlight/equity-market-structure/issues-affecting-customers-emsac012616.pdf. See generally

Robert H. Battalio & Tim Loughran, Does Payment For Order Flow To Your Broker Help Or Hurt You?, 80 T. J BUS. ETHICS

37 (2008). 767 17 C.F.R. § 242.606(a)(1)(iii) (2005). 768 U.S. SEC. & EXCH. COMM’N, SEC Adopts Rules That Increase Information Brokers Must Provide to Investors on Order

Handling (Nov. 2, 2018) https://www.sec.gov/news/press-release/2018-253. (“Routing Rule Press Release”). 769 Routing Rule Press Release (“The requirement to provide a report on the handling of not held orders… will be subject

to two de minimis exceptions, one at the firm-level and the other at the customer-level.”). 770 SEC Routing Rule Release at 124. 771 Id.

https://www.sec.gov/spotlight/equity-market-structure/issues-affecting-customers-emsac012616.pdf


net aggregate amount of any payment for order flow received, payment from any profit-sharing

relationship received, transaction fees paid, and transaction rebates received.772 Broker-dealers

must publicize these reports online for three years.773 Together, the rules require greater trans-

parency with respect to order routing in general and compensation arrangements in particular.

Tick sizes are the minimum price variation (“MPV”) for quotations for stocks. Prior to 2000, the

majority of exchanges set tick sizes at fractions (e.g., 1/8th) of a dollar.774 But in 2000, the SEC

directed the exchanges to develop a plan to convert their quotations from fractions to decimals,775

primarily because fractional tick sizes were creating wide spreads and increasing transaction costs

for investors.776 The SEC set the current MPV at one cent for listed stocks that trade above $1 per

share.777 Rule 612 of Reg NMS, the “sub-penny rule,” generally prohibits any trading venue from

publicly displaying, ranking, or accepting orders in increments smaller than one penny.778

Tick size pilot program

The SEC approved a Tick Size Pilot Program that commenced on October 2016 and ran for two

years as scheduled.779 Under the program, the MPV for certain smaller-capitalization stocks was

temporarily increased to $0.05 in order to examine the effect of larger minimum tick sizes on

liquidity.780 The exchanges and FINRA submitted a joint assessment of the impact of the program

to the SEC in August 2018,781 and the program expired in September 2018.782 The FINRA assess-

ment revealed relatively unimpressive results and found that the program: (i) may have increased

liquidity displayed at the NBBO, but also widened effective spreads; (ii) did not appear to increase

the number of market makers per security, but it did increase their volume and profit; and (iii)

772 Id. at 135. 773 James Dombach, SEC Adopts Amendments to Regulation NMS to Expand Disclosure, MURPHY & MCGONIGLE P.C. (Nov.

5, 2018), https://www.mmlawus.com/newsitem/alerts/sec-adopts-amendments-to-regulation-nms-to-expand-disclo-

sure-632/. 774 See SEC Division of Market Regulation, Market 2000: An Examination of Current Equity Market Developments, U.S.

SEC. & EXCH. COMM’N 37 (Jan. 1994), https://www.sec.gov/divisions/marketreg/market2000.pdf. 775 Order Directing the Exchanges and the National Association of Securities Dealers, Inc. to Submit a Phase-In Plan to

Implement Decimal Pricing in Equity Securities and Options, Exchange Act Release No. 42914, 65 FED. REG. 38010 (June

8, 2000), available at https://www.sec.gov/rules/other/34-42914.htm. 776 Report to Congress on Decimalization, As Required by Section 106 of the Jumpstart Our Business Startups Act, U.S.

SEC. & EXCH. COMM’N 4–5 (July 2012), https://www.sec.gov/news/studies/2012/decimalization-072012.pdf. 777 Rule 612(a) applies to stocks priced above $1.00; Rule 612(b) applies a different set of tick size rules to stocks with a

share price below $1.00. Compare 17 C.F.R. § 242.612(a) (2005) with 17 C.F.R. § 242.612(b (2005). 778 17 C.F.R. § 242.612(a) (2005). 779 U.S. SEC. & EXCH. COMM’N, Statement on the Expiration of the Tick Size Pilot (Sept. 10, 2018),

https://www.sec.gov/news/public-statement/tm-dera-expiration-tick-size-pilot. 780 U.S. SEC. & EXCH. COMM’N, Tick Size Pilot Program, https://www.sec.gov/ticksizepilot (last accessed Apr. 16, 2019). 781 FINANCIAL INDUSTRY REGULATORY AUTHORITY, Assessment of the Plan to Implement a Tick Size Pilot Program (Aug. 2, 2018),

https://www.sec.gov/files/TICK%20PILOT%20ASSESSMENT%20FINAL%20Aug%202.pdf (“FINRA Assessment”). 782 U.S. SEC. & EXCH. COMM’N, Statement on the Expiration of the Tick Size Pilot (Sept. 10, 2018),

https://www.sec.gov/news/public-statement/tm-dera-expiration-tick-size-pilot.


appears to have driven some trading off-exchange.783 But the SEC has not publicized its conclu-

sions on the results and implications of the program. There are presently no plans for the SEC to

increase the MPV of smaller capitalization stocks to $0.05.

In the United States, there are no regulatory definitions or requirements that apply specifically to

traders engaged in electronic trading, algorithmic trading or HFT in equity markets. However, any

firm trading directly on an exchange must (i) be a registered broker-dealer with the SEC and (ii)

become a member of an SRO, including FINRA and/or one of the national securities exchanges.784

Therefore, if a firm engaged in algorithmic trading or HFT seeks to trade directly on an exchange,

then it would be subject to the regulatory requirements that apply to broker-dealers.

The SEC, FINRA and the national securities exchanges have adopted rules applying risk-controls

to broker-dealers that increase in stringency based on their activities. For example, FINRA’s Net

Capital Rule requires broker-dealers to maintain minimum levels of liquid assets, or net capital.785

In addition, the SEC requires broker-dealers with access to trading on an exchange or ATS to

maintain “risk management controls and supervisory procedures that, among other things, are

reasonably designed to (1) systematically limit the financial exposure of the broker or dealer that

could arise as a result of market access, and (2) ensure compliance with all regulatory require-

ments[.]”786 NASDAQ’s rules for broker-dealer members explicitly incorporate FINRA’s require-

ment that members establish a supervisory control system to ensure compliance with applicable

rules and regulations.787 NYSE rules set a ceiling on the number of shares eligible for automatic

783 FINRA Assessment at 41–43 (Specifically, “lower-priced, higher-volume securities with the tightest pre-Pilot spreads

experienced wider quoted spreads, longer inter-market price-time priority queues and greater fragmentation of trading

volume” and “higher-priced, lower-volume stocks with the widest pre-Pilot spreads tended to experience the biggest

reductions in quoted spreads and were not as affected by greater fragmentation.”). 784 U.S. SEC. & EXCH. COMM’N, Guide to Broker-Dealer Registration (Apr. 2008), https://www.sec.gov/reportspubs/inves-

tor-publications/divisionsmarketregbdguidehtm.html#I (“Before it begins doing business, a broker-dealer must become

a member of an SRO. ... FINRA and the national securities exchanges are all SROs. If a broker-dealer restricts its trans-

actions to the national securities exchanges of which it is a member and meets certain other conditions, it may be

required only to be a member of those exchanges. If a broker-dealer effects securities transactions other than on a

national securities exchange of which it is a member… including any over-the-counter business, it must become a

member of FINRA, unless it qualifies for the exemption in Rule 15b9-1.”); U.S. SEC. & EXCH. COMM’N, SEC Proposes Rule

to Require Broker-Dealers Active in Off-Exchange Market to Become Members of National Securities Association (Mar.

25, 2015), https://www.sec.gov/news/pressrelease/2015-48.html. 785 Net capital requirements for brokers or dealers, 17 C.F.R. § 240.15c3-1; FINANCIAL INDUSTRY REGULATORY AUTHORITY, Net

Capital Requirements for Brokers or Dealers (2014), https://www.finra.org/sites/default/files/Interpreta-

tionsFOR/p037763.pdf. 786 U.S. SEC. & EXCH. COMM’N, Risk Management Controls for Brokers or Dealers with Market Access, Exchange Act Release

No. 34-63241 (Nov. 3, 2010), https://www.sec.gov/rules/final/2010/34-63241.pdf. 787 The Nasdaq rule incorporates NASD Rule 3012, which was subsequently superseded by FINRA Rule 3120. Nasdaq

Rule 3012 (“Members and persons associated with a member shall comply with NASD Rule 3012 as if such Rule were

part of Nasdaq's rules.”); FINRA, 3012: Supervisory Control System, http://finra.complinet.com/en/display/dis-

play_main.html?rbid=2403&element_id=3722&print=1 (“NASD Rule 3012 has been superseded by FINRA Rule 3120.”);

FINRA Rule 3120: Supervisory Control System, http://finra.complinet.com/en/display/display.html?rbid=2403&ele-

ment_id=11346.


order execution, implicitly limiting the size of orders that can be entered in an automated fash-

ion.788 For its part, FINRA guidance indicates that it views the requirement to publish only bona

fide offers to buy or sell as being relevant to algorithmic trading, even if the rule itself does not

specifically single HFT strategies.789 The SEC has also approved exchange rules prohibiting their

members from engaging in or facilitating disruptive quoting and trading activity and giving the

power to cut off-exchange access when a member engages in such activity.790 Thus, although U.S.

securities markets lack a regulatory regime that specifically addresses algorithmic trading or HFT,

registered broker-dealers are subject to various SEC and SRO regulations that ultimately do gov-

ern algorithmic trading and HFT.

Firms that do not trade directly on an exchange (and are therefore not required to register as

broker-dealers) can obtain “sponsored” access to an exchange through a registered broker-dealer.

SEC Rule 15c3-5 imposes minimum standards on these arrangements that are also intended to

mitigate trading risk. For example, broker-dealers may only provide a market participant with

sponsored access if the broker-dealer has established reasonable credit and capital thresholds for

the market participant.791 The broker-dealer must also maintain risk management controls and

supervisory procedures for the market participant.792 These standards are intended to mitigate

the risk that a market participant with sponsored access could cause solvency concerns for the

broker-dealer or volatility in the markets.

In 2014, the SEC adopted Regulation Systems Compliance and Integrity (“Reg SCI”), which im-

poses compliance and monitoring requirements on most trading venues, including exchanges and

788 NYSE Rule 1000: Automatic Execution (“Market and limit orders of such size as the Exchange may specify from time

to time are eligible to initiate or participate in automatic executions. Orders up to 1,000,000 shares are eligible for

automatic execution. Incoming orders of more than 1,000,000 shares that are marketable on arrival will be rejected.

Upon advance notice to market participants, the Exchange may increase the order size eligible for automatic executions

up to 5,000,000 shares on a security-by-security basis.”). 789 FINANCIAL INDUSTRY REGULATORY AUTHORITY, Algorithmic Trading, Rules, http://www.finra.org/industry/algorithmic-trad-

ing (last accessed Apr. 28, 2019); FINRA 5210. Publication of Transactions and Quotations (“No member shall publish or

circulate, or cause to be published or circulated, any notice, circular, advertisement, newspaper article, investment ser-

vice, or communication of any kind which purports to report any transaction as a purchase or sale of any security unless

such member believes that such transaction was a bona fide purchase or sale of such security; or which purports to

quote the bid price or asked price for any security, unless such member believes that such quotation represents a bona

fide bid for, or offer of, such security.”). 790 See Order Approving BATS Proposed Rule Changes Relating to Disruptive Quoting and Trading Activity, Exchange

Act Release No. 77171, 81 Fed. Reg. 9017 (Feb. 18, 2016); Rules of BATS BZX Exchange, Inc., BATS, at Rules 12.15, 8.17,

http://cdn.batstrading.com/re sources/regulation/rule_book/BATS_Exchange_Rulebook.pdf. 791 17 C.F.R. § 240.15c3-5; U.S. SEC. & EXCH. COMM’N, Risk Management Controls for Brokers or Dealers with Market Ac-

cess, Exchange Act Release No. 34-63241 (Nov. 3, 2010), https://www.sec.gov/rules/final/2010/34-63241.pdf. 792 Id.


ATSs that exceed certain volume thresholds.793 Reg SCI enhances the SEC’s oversight of U.S. se-

curities markets’ technology infrastructure in order to reduce the occurrence of systems issues

and improving resiliency when such issues do occur.794

Relatedly, the SEC has taken steps to improve its ability to perform ongoing surveillance and re-

construct market activity. In 2011, the SEC imposed registration and reporting requirements on

traders that exceed defined volume thresholds, which allow the SEC to see how these major trad-

ers interact with securities markets and reconstruct trading activity following periods of extreme

market volatility.795 Likewise, in 2013, the SEC introduced the Market Information Data Analytics

System (MIDAS), its official trade monitoring system; MIDAS gives the SEC the ability to recon-

struct trading activity after extreme market events and detect illegal trading behavior.796 In addi-

tion, in 2012 the SEC adopted Rule 613, requiring national securities exchanges and FINRA to

submit plans to create, implement, and maintain a consolidated audit trail designed to track the

life cycle of all orders and trades, in order to allow regulators to track market activity more accu-

rately and efficiently.797 By creating a central repository of trading data, the SEC and other regu-

lators aim to link customer account information to order event data and perform ongoing surveil-

lance while also enabling complete market reconstructions.798

The SEC has focused its enforcement resources on policing forms of market manipulation, such

as quote stuffing (sending and instantly canceling a large number of orders to cause delays in

execution of the orders of other traders), smoking (posting short-lived quotes inside the spread

to tease slower traders to cross the spread) and spoofing (posting quotes away from the spread

in order to create the illusion of trading interest).799 Although these activities can be facilitated

using algorithmic trading, they are also employed by human beings to take advantage of other

traders using legitimate algorithmic trading strategies.

793 See 17 C.F.R. §§ 242.1000-07 (2017). Reg SCI also applies to other SROs (such as registered clearing agencies, and

FINRA), disseminators of consolidated market data and certain exempt clearing agencies. 794 See SEC, Regulation SCI Adopting Release, Exchange Act Release No. 73639, 79 Fed. Reg. 72252, 72410 (Dec. 5, 2014)

(“The Commission believes that including market regulation and market surveillance systems under the definition of

SCI systems should help ensure the robustness of the systems used by SCI entities to monitor compliance with relevant

laws, rules, and their own rules, and detect any violations of such laws or rules by… participants”). 795 See Large Trader Reporting Adopting Release, Exchange Act Release No. 64976, 76 Fed. Reg. 46960 (Aug. 3, 2011)

(codified at 17 C.F.R. § 240.13h-I) (requiring registration by entities who trade either two million shares or $20 million

during any calendar day, or 20 million shares or $200 million during any calendar month). 796 See Frank Konkel, SEC’s MIDAS program highlights how to do big data, FCW (Mar. 28, 2014), https://fcw.com/arti-

cles/2014/03/28/sec-midas-big-data.aspx (noting that MIDAS collects more than one billion time-stamped records per

day from each of the 13 national equity exchanges in near real time). 797 See Consolidated Audit Trail Adopting Release, Exchange Act Release No. 67457, 77 Fed. Reg. 45722 (Aug. 1, 2012)

(codified at 17 C.F.R. § 242.613). 798 See id. 799 See SEC, SEC Charges New York-Based High Frequency Trading Firm With Fraudulent Trading to Manipulate Closing

Prices (Oct. 16, 2014), available at https://www.sec.gov/News/PressRelease/Detail/PressRelease/1370543184457; SEC,

SEC Charges Firm and Owner with Manipulative Trading (Oct. 8, 2015), available at https://www.sec.gov/news/pressre-

lease/2015-236.html.


The SEC has indicated that additional regulation of HFT firms may be on the horizon. In 2015, the

SEC proposed eliminating or narrowing exemptions that allow some HFT firms to forego FINRA

registration, which would expand the number of HFT firms subject to FINRA examinations and

enforcement actions.800 The proposed rule has not yet been finalized. However, the SEC has ap-

proved a 2016 amendment to FINRA’s rules that requires each person who is primarily responsible

for the design, development or significant modification of an algorithmic trading strategy relating

to equity securities, or who is responsible for the day-to-day supervision or direction of such ac-

tivities, to register with FINRA as a “securities trader” and pass qualification exams.801

Market-wide circuit-breakers

Market-wide circuit breakers are designed to briefly shut down trading in all stocks across all

trading venues to promote the orderly functioning of markets. Shutting down trading during pe-

riods of high volatility can promote the orderly functioning of markets, because doing so provides

market participants with additional time to assess new information and significant changes in

market prices and to adjust automated trading systems that may be executing trades at unin-

tended prices. This can reduce the market impact of abrupt price movements.802 The SEC’s market-

wide circuit breakers are triggered at price declines of 7%, 13%, and 20%.803 The SEC uses the S&P

500 as the reference index.804

800 See SEC, Exemption for Certain Exchange Members, Exchange Act Release No. 74581, 80 Fed. Reg. 18036, 18038–39

(proposed Apr. 2, 2015). The proposed amendment would eliminate certain allowances for off-exchange and proprietary

trading, replacing it “with a more targeted exemption from [FINRA registration] for a broker-dealer that conducts busi-

ness on a national securities exchange” and trades off-exchange solely for hedging purposes. Id. at 18045–46. 801 See Exchange Act Release No. 77551 (Apr. 7, 2016), 81 Fed. Reg. 21914 (Apr. 13, 2016) (Order Approving File No. SR-

FINRA-2016-007). The goal of the amendment, according to FINRA, is to ensure that HFT firms identify and register one

or more associated persons who possess knowledge of, and responsibility for, both the design of the intended trading

strategy and its technological implementation to evaluate whether it is designed in accordance with regulatory require-

ments. See FINRA, Qualification and Registration of Associated Persons Relating to Algorithmic Trading, Regulatory Notice

16-21 (June 2016), available at https://www.finra.org/sites/default/files/Regulatory-Notice-16-21.pdf. 802 Findings Regarding the Market Events of May 6, 2010, Report of the Staffs of the CFTC and SEC to the Joint Advisory

Committee on Emerging Regulatory Issues 7 (Sept. 30, 2010), https://www.sec.gov/news/studies/2010/marketevents-

report.pdf. 803 Self-Regulatory Organizations; Notice of Filing of Amendments No. 1 and Order Granting Accelerated Approval of


Volatility, Exchange Act Release No. 67090 (May 31, 2012) http://www.sec.gov/rules/sro/bats/2012/34-67090.pdf; Self-

Regulatory Organizations; New York Stock Exchange LLC; Order Approving a Proposed Rule Change, as Modified by

Amendment No. 1, To Require Certain Member Organizations To Participate in Scheduled Market-Wide Circuit Breaker

Testing, Exchange Act Release No. 34-83836 (Aug. 13, 2018), https://www.federalregister.gov/docu-

ments/2018/08/17/2018-17743/self-regulatory-organizations-new-york-stock-exchange-llc-order-approving-a-pro-

posed-rule-change-as, footnote 5. 804 Self-Regulatory Organizations; Notice of Filing of Amendments No. 1 and Order Granting Accelerated Approval of


Volatility, Exchange Act Release No. 67090 (May 31, 2012) http://www.sec.gov/rules/sro/bats/2012/34-67090.pdf; Self-

Regulatory Organizations; New York Stock Exchange LLC; Order Approving a Proposed Rule Change, as Modified by

Amendment No. 1, To Require Certain Member Organizations To Participate in Scheduled Market-Wide Circuit Breaker


Trading halts for individual stocks

In 2012, the SEC approved the “Limit Up-Limit Down” (“LULD”) mechanism, proposed in a Reg

NMS plan put forward by the US exchanges and FINRA,805 to address extraordinary market vola-

tility.806 The LULD mechanism provides market-wide, single stock price bands that ‘are designed

to prevent trades in individual NMS stocks outside of specified price bands, while allowing trading

to continue when the price move is transitory’.807 Trading in a security is paused for five minutes

if price volatility is not quickly corrected (i.e., if, but-for the pause, orders would execute outside

of the band).808 LULD thus protects market participants from trading at extreme and unintended

prices and provides time for them to adjust their orders during periods of volatility. The price band

for each stock is calculated by the SIP responsible for consolidating information for each NMS

stock.809 The plan defines price bands for two distinct group of securities, Tier 1 NMS Stock (S&P

500, the Russell 1000, and some high-volume exchange-traded ETFs) and Tier 2 NMS Stock (the

remainder of the NMS stocks).810

The width of LULD price bands doubles at the close of trading, between 3:35pm and 4:00 pm (or

in the case of an early scheduled close, during the last 25 minutes of trading before the early

scheduled close), for all stocks except Tier 2 NMS Stock with a reference price above $3.00.811

Price collars

In addition to the operation of the LULD mechanism, some US exchanges have in place rules that

provide for price collars812 in their opening, closing and/or reopening auctions, to reduce the risk

Testing, Exchange Act Release No. 34-83836 (Aug. 13, 2018), https://www.federalregister.gov/docu-

ments/2018/08/17/2018-17743/self-regulatory-organizations-new-york-stock-exchange-llc-order-approving-a-pro-

posed-rule-change-as, footnote 5. 805 See https://www.sec.gov/rules/sro/nms/2019/34-85623.pdf , footnote 1. 806 The plan, submitted pursuant to Section 11A of the Exchange Act 1934 and Rule 608 of Regulation NMS, was first

approved on a pilot basis by the SEC on May 21, 2012. It was amended a number of times, with the latest, eighteenth

amendment, converting it from a pilot to a permanent basis (and approving a number of significant amendments) on

April 11, 2019. See Joint Industry Plan; Order Approving the Eighteenth Amendement to the National Market System

Plan to Address Extraordinary Market Volatility (Release No. 34-85623; File No 4-631)

https://www.sec.gov/rules/sro/nms/2019/34-85623.pdf 807 Moise & Flaherty, ‘‘Limit Up-Limit Down’ Pilot Plan and Associated Events’ (March 2017), page 7, at

https://www.sec.gov/files/dera-luld-white-paper.pdf 808 Id. 809 Pursuant to Rule 603(b) of Regulation NMS. For more information on calculation of price bands, see

http://www.luldplan.com 810 Moise & Flaherty, ‘‘Limit Up-Limit Down’ Pilot Plan and Associated Events’ (March 2017), page 7; NYSE, ‘Volatility

Mechanisms’ at https://www.nyse.com/publicdocs/nyse/products/etp-funds/ETF_NYSE_Volatility_Fact_Sheet.pdf 811 Joint Industry Plan, page 23, https://www.sec.gov/rules/sro/nms/2019/34-85623.pdf 812 Price or trading collars impose restrictions on execution of marketable orders when automatic executions are in

effect. The collars are set a given percentage away from the NBBO, with an incoming order neither executing nor

routing away to a price equal to or inferior to the collar (the exact collar conditions will vary from exchange to exchange).

SEC Division of Trading and Markets, Memorandum to Equtiy Market Structure Advisory Committee, January 26, 2016,

available at https://www.sec.gov/spotlight/equity-market-structure/issues-affecting-customers-emsac-012616.pdf

page 5, footnote 16.


of a poor execution price.813 For example, NYSE American814 has price collar thresholds815 for the

indicative match price for its core open auctions, trading halt auctions and closing auctions, with

the collar being based on a price that is the greater of $0.50 or 10% away from the auction refer-

ence price.816

“Breaking” clearly erroneous trades

SROs have the authority necessary to cancel, or “break,” trades on any trading venue, if a trade

exceeded a minimum percentage deviation from the last trade.817 In other words, two counter-

parties that entered into a trade on an exchange would no longer be bound by their trade if an

exchange broke that trade. Similarly, FINRA can break the trades of ATSs and broker-dealer inter-

nalizers.818 This power to nullify trades protects investors from being bound by unintentional

trades at terms they clearly would not have intended to accept, thereby promoting fair and orderly

markets.

Kill switches

Kill switches halt trading for a specific market participant on a trading venue when that entity’s

trading activity has breached a pre-established exposure threshold on that trading venue.819 They

are thus intended to prevent a specific market participant’s erroneous orders or uncontrolled ac-

cumulation of unintended positions. Certain exchanges currently offer kill switches for broker-

dealer members,820 but they are optional and non-uniform.

813 Id. 814 Exchange for growing companies. 815 For more detail, see https://www.nyse.com/markets/nyse-american/trading-info 816 NYSE was fined by the SEC in 2018 for the use of price collars by NYSE Arca (its market for exchange-traded funds,

ETFs) during reopening auctions that followed LULD pauses during the August 24, 2015 ETF market volatility. SEC con-

sidered that, by applying price collars, Arca’s order imbalances on reopening auctions resolved more slowly than they

would have otherwise and potentially limited the extent to which the prices on reopening could adjust to changing

conditions without triggering additional LULD halts. NYSE Arca rules described price collars for opening and closing

auctions, but not for reopening auctions and, accordingly, Arca violated section 19(b)(1) of the Exchange Act because

it did not comply with its rules. See SEC, ’NYSE to pay $14 Million Penalty for Multiple Violations’ (March 6, 2018), at

https://www.sec.gov/news/press-release/2018-31 817 Order Granting Approval of Proposed Rule Changes Relating to Clearly Erroneous Transactions, Exchange Act Re-

lease No. 62886, 4–5 (Sept. 10, 2010) https://www.sec.gov/rules/sro/bats/2010/34-62886.pdf; Self-Regulatory Organi-

zations; NYSE American LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Extend the

Current Pilot Program Related to Rule 7.10E, Clearly Erroneous Executions, Exchange Act Release No. 34-85563, 2-3

(Apr. 9, 2019), https://www.sec.gov/rules/sro/nyseamer/2019/34-85563.pdf. 818 FINRA Rule 11892, http://finra.complinet.com/en/display/display_main.html?rbid=2403&element_id=8854. 819 Prepared Written Testimony Before the S. Comm. on Banking, Housing, and Urban Affairs, 113th CONG. 2 (2014)

(statement of Hal S. Scott, Nomura Professor and Director of the Program on International Financial Systems, Harvard

Law School). 820 See, e.g., NASDAQ, Equity Kill Switch: Frequently Asked Questions, available at https://www.nasdaqtrader.com/con-

tent/EquityKillSwitch.pdf.


Regulatory trading halts

Exchanges have the authority to call regulatory trading halts for their listed securities under the

NMS Plans that cover NYSE-listed securities and NASDAQ-listed securities.821 Once a listing ex-

change decides a regulatory halt is appropriate and institutes one, the listing exchange must no-

tify the other SROs. Regulatory trading halts are generally effective across all trading venues.822

Regulatory trading halts may be called due to (i) inadequate or pending disclosure of material

information to the public; or (ii) “regulatory problems relating to” a security “that should be clari-

fied before trading therein is permitted to continue,” including extraordinary market activity due

to system misuse or malfunction.

821 NYSE Rule 7.18 – Halts (Mar. 8, 2019), http://wallstreet.cch.com/NYSETools/PlatformViewer.asp?selected-

node=chp_1_2_1_9_1_10&manual=%2Fnyse%2Frules%2Fnyse-rules%2F (“If the UTP Listing Market declares a UTP Reg-

ulatory Halt, the Exchange will halt trading in that security…”); Nasdaq Rule 4120 - Limit Up-Limit Down Plan and Trading

Halts (Sept. 3, 2018), http://nasdaq.cchwallstreet.com/nasdaq/main/nasdaq-equi-

tyrules/chp_1_1/chp_1_1_4/chp_1_1_4_1/chp_1_1_4_1_1/chp_1_1_4_1_1_2/default.asp. 822 Bidisha Chakrabarty et al., When a Halt is Not a Halt: An Analysis of Off-NYSE Trading during NYSE Market Closures,

J. OF FIN. INTERMEDIATION 2 (2011), http://www3.nd.edu/~scorwin/documents/OffNYSETrading_000.pdf (noting that regu-

latory halts are “generally coordinated” across venues); When Trading Stops: What You Need to Know About Halts,

Suspensions and Other Interruptions, FIN. IND. REG. AUTH., https://www.finra.org/investors/alerts/when-trading-stops-

halts-suspensions-other-interruptions (last updated Feb. 7, 2013) (noting that all “markets trading the stock must ob-

serve the trading halt”).

~ 40 ~

Program on International Financial Systems (PIFS) 134 Mount Auburn Street, Cambridge, MA 02138 www.pifsinternational.org